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How Payroll Systems Work

Choosing a Payroll System
Smaller companies may not need sophisticated systems to handle payroll.
Smaller companies may not need sophisticated systems to handle payroll.

It can be difficult to decide which payroll system is the best fit for your business. The most important factors are the size of your business and the budget you're willing to spare on payroll processing.

For a very small company -- five employees or fewer -- it's certainly possible for a business owner to handle all of the payroll obligations himself with nothing but a calculator and an Excel spreadsheet. But that's only if the business owner is interested or at all gifted in basic accounting. If you're terrible with numbers, then calculating withholdings yourself will not only take more time than it should, but will be prone to mathematical errors. Not only will you waste valuable work time, but you'll potentially get yourself into financial or legal trouble. But if you have a knack for crunching numbers, then handling payroll for a small number of employees could be quite satisfying.

For a medium-sized company -- 10 to 50 employees -- it's no longer feasible to do everything by hand. This is where payroll software probably makes the most sense. For a relatively low cost per month, you can have the computer do all of the grunt work for you. You'll still have to stay up to date with paychecks and tax filings, but it's just a matter of clicking a button, not doing all of the calculations and filling out all of the forms yourself. If you have the budget to spare, or you're just not interested in this aspect of the business, then you could even hire an HR specialist who could manage the software along with his or her other duties.

For larger companies -- up to 100 employees -- even the software will begin to reach its limitations. You might find that you're spending too much time updating wage and employee information for new hires and fires. Or maybe you're starting to get nervous about trusting a machine to cut checks and file taxes for truly large sums of money. Now is probably the time to hire an in-house payroll specialist or outsource to a payroll service. In either case, you'll have the peace of mind that professionals are handling all of the details and devoting their full attention to the process.

No matter which option you choose, here are some criteria to consider:

  • Security - If you're using software, is it password-protected? Can only certain personnel access the payroll information? If you use a payroll service, where will your data be stored? Do they have a disaster recovery plan in the event of a system crash?
  • Compatibility - How well does the payroll system jibe with your other business systems, like accounting and HR? If you use a software solution, does it interface with your other business management software? If not, you might consider buying all of your financial and HR software from the same provider so that information is shared among all systems. If you use an outsourced payroll service, how easy it is for them to communicate with your in-house accountants and HR personnel?
  • Credibility - If you're using a payroll service, is it rated by Standard ­& Poor's or Moody's? If you're interested in software, is it made by a well-known brand with a solid reputation?
  • Flexibility - Will the software or service grow with your business?
  • Control - As a business owner, how much control do you want over the payroll system? Even if you don't want to handle the day-to-day responsibilities, will your service allow you to request a report, view payment histories and make real-time changes to employee wage information when necessary [source: Hakala]?

We hope this has been a helpful introduction to payroll systems. For lots more information about running a small business, follow the links on the next page.