Starting your company: How to set up and manage payroll for the first time

If you’ve just started your own company, having skilled employees can really help you get your business off the ground. Whether you’re planning to hire your first starter or are rapidly expanding, it’s crucial that you have payroll set up and working properly.

If you don’t set up your payroll properly your employees might not get paid on time 一 or not at all 一 and you could be hit with a fine from HM Revenue and Customs (HMRC).

To help you avoid costly penalties and unhappy staff, our guide to setting up payroll will walk you through everything you need to know - from understanding how to set up the system to managing it correctly to ensure your business can run smoothly.

What is a payroll and why is it important for your business?

Put simply, payroll is the process of calculating your employees’ pay and letting HMRC know how much they have been paid. 

To work this out, there are a few steps that you must take:

• Total up salary and any other pay — Additional pay is things like bonuses
• Include any deductions — Deducting things like tax and National Insurance
• Calculate National Insurance contributions — Your business will need to pay out National Insurance contributions as long as the earnings are over £184 a week 
• Create and send payslips — All employees must receive either a physical or electronic copy of their payslip
• Pay your employees — You must ensure that all employees are paid on time in accordance with their contracts, whether this is weekly or monthly payments
• Report their pay and deductions — You must report all payments and deductions from wages to HMRC

Who do I need to include on my payroll?

Essentially, anyone your company employs and pays to fulfil a job role needs to be on payroll (except for independent contractors, but more on that later). Even if you are the CEO, you’re still an employee, and you need to be included on the payroll as well. If you’re wondering how to pay yourself if you’re a small business owner, take a look at our handy guide.

What is PAYE?

PAYE stands for ‘Pay As You Earn’ and is a method for deducting tax and National Insurance from wages. When you’ve worked out how much that is, it’s your responsibility as an employer to pay it to HMRC.

PAYE Online is the portal where you can send payroll information to HMRC and make the required payments. By using PAYE Online, you’ll be able to view certain information about your employees. This includes:

• Tax code notices (P6 and P9)
• Student loan notices (SL1 and SL2)
• National Insurance verification notices (NVR and NOT)
• Late reporting and late payment notifications

Typically, an employee's tax code will tell you how much tax to deduct from their pay for the PAYE process.

Methods for managing payroll

When you come to set up your payroll, there are two different methods that you can choose from: processing it in-house or outsourcing it. 

If you’re a first-time business owner, it can be difficult to know which payroll method to opt for. Keeping it in-house and outsourcing each has its advantages, so you should look into both to work out which one is better suited to your business.

Managing payroll in-house

If you want to keep the process of payroll within your company, you’ll need to use a specific tool to help you manage the accounting side of things. HMRC offers a basic, free payroll software that you can use if you have less than ten employees. It allows you to work out your employees’ deductions and send this information to them. Aside from HMRC’s offering, you can also find a list of HMRC-tested and approved free payroll software here.    

Alternatively, if you have more than 10 employees, you might need more complex software. HMRC also has a list of paid-for software that they’ve tested.

Benefits of in-house

• Gives you the flexibility to manage payroll how you want to
• Offers more control over your finances
• Able to catch any errors quickly
• Cost-effective as you don’t need to pay an external company

Outsourcing to an external payroll company

If you don’t have the time or resources to manage payroll, outsourcing the job to an external company may be the better option for your business. Once you have found a company that suits your needs, they’ll be able to look after the whole payroll process for you. 

Benefits of outsourcing

• A good option for small or medium-sized businesses who want to prioritise their time elsewhere
• Can be sure that it’s being managed by professionals
• Less chance of making mistakes
• Payroll will always be completed on time

How to set up payroll for your business

If you settle for managing payroll in-house, here are the steps you need to take to set it up.

1. Register as an employer 

You’ll first need to register as an employer with HMRC. This needs to be done before your employees’ first payday, and it can take up to five working days to receive your employer PAYE reference number. You’ll need to include this number on all payslips, so make sure to register in advance of payday 一 however, you can’t register more than two months before you wish to start paying people.

2. Set up PAYE Online 

Next, you need to get set up on PAYE Online. This is what you’ll use to report tax information to HMRC. You should receive your PAYE Online login shortly after registering as an employer. If you don’t get it, you might need to enrol to PAYE Online instead.

3. Choose a payroll software 

You’ll need to find payroll software that works for you. Whether you select HMRC’s free software, one that HMRC has tested, or something else entirely, it’s important to find something that will be able to cope with all your payroll needs. You’ll have to consider important factors like: 

• How many employees you have
• The size of your business
• If you have a budget for payroll
• How often you will need to process payroll
• Who will process payroll
• Whether you use physical or electronic payslips

4. Record employees’ details

For your employees’ first payday and whenever new recruits start at your business, you will need to tell HMRC by updating PAYE with their details. 

First, make sure that your employees meet the criteria to be paid via PAYE. This is usually if they earn £120 or more a week. Self-employed employees, like freelancers, don’t need to be paid with PAYE.

If they do, you will then need to register their tax code to view any outstanding student loans. Once that’s been checked, use a Full Payment Submission (FPS) to register them with HMRC. 

An FPS is a document that employers must use to submit information about their employees to HMRC. Here, it’s used to provide details on their tax and contributions. Ahead of each payday, employers will also need to use one to report their employees’ pay and deductions, as well as what the business owes HMRC through National Insurance.

5. Keep records

Throughout the process of running payroll, you must keep track of certain records relating to your employees. You need to make note of leave of absences like annual, maternity and sick leave, tax code notices, and any taxable expenses or benefits. 

These records should be kept for three years from the end of the tax year that they’re from, and they can be stored physically on paper or digitally on your payroll system. This is in case HMRC asks to check your records to make sure that you’re paying the correct amount of tax. If you don’t keep this information recorded, you may be issued a fine of up to £3,000.

6. Work out employees pay and deductions

Ahead of each payday, your business must make sure that your employees are paid on time and with the correct amount. Use your payroll system to:

• Record their pay
• Calculate any deductions and National Insurance contributions
• Work out how much National Insurance you need to pay on their earnings
• Generate a physical or digital payslip

7. Report payroll information to HMRC

As well as getting your employees’ pay in order, you also need to tell HMRC about how much you’ll be paying them and what will be deducted. This should all be done using an FPS.

The FPS should be sent on or before payday. This must be done even if you pay HMRC quarterly rather than monthly.

8. Work out how much will need to be paid to HMRC

Once the deductions have been reported, you’ll then have to work out what your business will need to pay HMRC. This will be the Income Tax and National Insurance you reported in the FPS in the last tax month. 

Your payroll software will be able to tell you how much needs to be paid per employee.

Types of payments you’ll need to record

Along with salary and deductions, there are a few other payments that you should always bear in mind when running payroll.

• Expenses and benefits — This includes things like uniforms and company cards. These should be reported separately at the end of the tax year using your payroll software.
• Tips — If tips are paid into a till, by cash, card, or cheque, they should be treated as regular pay. Things like bonuses, commission, holiday pay, time spent travelling, medical suspension payments, maternity suspension payments, and guarantee payments should also be recorded as normal pay.
• Student loan repayments — Use your payroll software to record if any of your employees need to make student loan repayments. The amount that they need to pay back will depend on which plan that they’re on.
• Statutory pay — If one of your employees was too sick to work and received statutory sick pay, it must be recorded in your payroll system as it will need to be taxed like normal pay.
• Pensions — After National Insurance payments have been calculated, but before tax, pension deductions must also be worked out. Your business will also need to pay part of your employees’ pension as an employer contribution.

How to get your payroll right

Payroll requires lots of care and attention to make sure your company is processing pay correctly. Get it right and your employees will be happy; get it wrong and you could run into some serious trouble with HMRC. To help you keep it running smoothly, here are a few things to stay on top of.

1. Check the minimum wage

The level of the Nation Living Wage and National Minimum Wage changes on April 1 every year, so you need to be aware of the increase in rates.

From April 2021, the National Minimum Wage applies to all employees between school-leaving age and under the age of 22. Anyone aged 23 or over will receive the National Living Wage.

If you hire apprentices within your company, they are entitled to the apprentice rate or minimum wage depending on their age and how long they have been employed by your business.

• Apprentice rate —  If they are aged 19 and under, or if they are over 19 and in the first year of their apprenticeship.
• Minimum wage —  If they are aged 19 and over and have completed the first year of their apprenticeship.

For more information on the most up-to-date wage rates in the UK, visit gov.uk

2. Record your employees’ statuses

If you hire independent contractors or freelancers, you must take note of this and factor it into the payroll process as they aren’t technically classed as your employees.

Freelancers are self-employed and are required to pay their own taxes and deductions. This means that they won’t receive a payslip as they won’t be paid via PAYE, and they aren’t entitled to the employment rights of your regular employees.

The process and method for paying independent contractors should be agreed upon at the start of their contract.

3. Meet your payment deadlines

Once you’ve paid your employees, you must submit an FPS to HMRC with all the required information. If you don’t, you risk missing your payment deadline and you might be penalised by HMRC.

HMRC will send you a late filing notice if you fail to send an FPS or if it’s sent late. They may also charge you a penalty fee if you don’t have a valid reason for doing so. In extreme cases, HMRC can close your PAYE portal if you’re a new employer and you don’t submit an FPR or pay your taxes within 120 days.

Setting up payroll correctly to keep your business running smoothly

Processing payroll on time and accurately at the end of each month is essential for any business with employees. Not only is it important to keep HMRC updated with regular tax information, but managing payroll also ensures that your employees will be paid for their hard work. 

As a new business owner, you might also want to consider taking out a tailored insurance policy for complete peace of mind in the event of the unexpected. Compare business insurance quotes today with Bionic.