How to Create a Payroll Budget

Payroll is undoubtedly one of the most significant business expenses, typically accounting for roughly 20% of an organization’s expenses. Neglecting this critical line item can quickly lead to the cost of doing business spiraling out of control. With a fluctuating workforce, you don’t need a crystal ball to forecast your payroll expenses for the year. A payroll budget can help you anticipate your payroll expenses and give you a clearer picture of your general operating budget.

The Easy Parts of Payroll Budgeting

If you’re already dreading creating a complex spreadsheet, now is a good time to relax. In any case, according to a Market Watch report, nearly 90% of spreadsheets contain errors. You’ll be using spreadsheets sparingly, if at all.

While online payroll services are excellent for processing payroll, they sometimes lack robust budgeting features. For this reason, a dedicated budgeting and forecasting tool is the best option. These tools help you quickly and accurately create payroll budgets. They also integrate with your accounting software to make the entire process seamless and straightforward.

Another reason to choose a budgeting and forecasting tool is its wide application. Your payroll budget is likely only one part of your business’s master budget. Using a single tool to manage the entire business budget streamlines your efforts, reduces costs, and decreases the chances of making errors.

The Difficult Parts of Payroll Budgeting

Picking a budgeting tool is the easy and maybe even fun part of payroll budgeting. Now comes the tricky part of putting together your budget. There’ll be many data points to consider when creating your budget. Missing just one of these crucial pieces of data can paint an inaccurate picture of your financial position. Meticulous attention to detail will ensure that you end up with an accurate budget. Also, the process will get easier as you get accustomed to creating your monthly and yearly payroll budgets.

Step 1: Sign Up for a Business Budgeting and Forecasting Tool

You’ll be doing a lot of budgeting and reporting for your business. It’s a good idea to get a comprehensive tool that automates your budgeting processes, including payroll, activity, and annual budgets. You could always go the traditional route of using spreadsheets for a small startup. Either way, you’ll recoup the cost of your budgeting tool through efficiency, time saved, and fewer fines and penalties resulting from poor payroll budgeting.

Choose a Budgeting Tool

You’ll be spoiled for choice on the market, but for this step, I chose Calxa. This tool easily integrates with your accounting software, including MYOB, Xero, and QuickBooks. You also don’t have to throw your old spreadsheets away. Calxa integrates with Excel to import crucial historical payroll data. It’s also a very user-friendly budgeting and forecasting tool.

This tool also allows you to create professional financial reports and project cash flow for your entire business in addition to payroll. It helps your planning to view all your financial projections on one simple interface.

Choose a Plan

Calxa offers four pricing plans ranging from $30 to $1000 per month. Since I’m only interested in company-level reporting for a small business, I chose the Express plan for $30 per month. This option works for most small to medium-sized businesses. You can configure everything in less than 30 minutes, so it’s straightforward to use.

All plans come with a 30-day free trial which you might want to take advantage of. The free trial will help you decide whether this is the right budgeting and forecasting tool for your business. You also don’t need to provide your credit card information to enjoy the free trial.

Whether you go with Calxa or another tool, the first step is to sign up with one to get started on creating your budget.

Step 2: Review Your Current Payroll

Before you can create a payroll budget, you need to be clear on who you pay. This is important since some employees, like temporary workers, can fall through the cracks. Also, make sure to classify independent contractors separately from your salaried employees. You don’t pay them the same way, and it’s easy to mix them up and apply bonuses and benefits to independent contractors who traditionally don’t qualify for these perks.

Compile a List of Positions

You probably already have a list of your employee data if you’ve done payroll before. You can easily import this list to your budgeting tool, including Calxa. Most software allows you to import Excel spreadsheets or data from your accounting software.

If not, start with compiling a list of everyone on your payroll. This includes yourself if you’re on the payroll. Positions to consider include:

  • Yourself
  • Admin staff
  • On-location employees
  • Remote employees
  • Hourly employees
  • Sales team
  • Temporary employees
  • Contractors/freelancers

You may need to refer this task to HR when budgeting for a large business or organization.

Review the Positions

If you plan on adding new employees, list the new positions. It helps if you have a projected start date to make your budget more accurate. If not, add the new positions anyway. It’s better to over-budget than under-budget payroll.

Don’t forget to factor in the related costs of hiring new employees, including salary, insurance, retirement contributions, vacation pay, severance pay, and other fringe benefits that your organization offers.

Step 3: Add Payroll Expenses for Each Position

The next part of creating your payroll budget is to assign expenses for each position you outlined in the previous step. Again, you’ll also have to consider new jobs in this step.

Compare Your Previous Year’s Payroll Expenses

If you notice that your payroll cost is more or less the same year after year, this step should be easy. Simply pull out last year’s expenses and use them to generate the costs for the budget you’re creating.

Calxa makes this process easy for you in a few simple steps:

  • Select Wages Account from the dashboard and click on the Formula button.
  • Click Data Source -> Actuals -> Period -> -12. This will pull up data from the previous year.
  • Click Selected Accounts on the left side of the Formula.
  • Click Apply Formula to recreate the budget.

Calxa integrates with your accounting software, so you can import your general ledger and use the same process to pull up the previous year’s payroll.

Budget Hourly and Salaried Employees

For the most part, budgeting for salaried employees is easy. This is especially true if you pay your employees monthly. To budget for monthly salaries, simply take your employee’s gross wages and divide them by 12 to get your monthly budget.

Things are slightly more complicated if you pay biweekly. Some months will have three paychecks, so you need to account for this factor. Calxa solves this problem quickly by using a repeating budget formula. The software automatically calculates the accurate number of pay periods in each month. To set your repeating formula on Calxa:

  • Click on your account and select Formula.
  • Select Repeating.
  • Enter the month’s start date along with the gross pay for each period.
  • Enter how often you’d like to repeat the calculation.
  • Click Apply Formula.

Finally, determining your hourly budget can be tricky. You’ll need to determine the number of hours worked per month per hourly employee. However, these hours may vary month to month. Your previous year’s payroll can help you determine the number of hours worked. Simply enter this information in your budgeting tool to budget for your hourly employees.

Again, you can do this by changing the formula to an hourly rate in the Number field when using Calxa for payroll budgeting.

Step 4: Add Other Payroll Expenses

Gross pay is far from the only payroll budget items you’ll be calculating. Again, looking at your previous year’s payroll can help you determine which expenses to account for in your budget.

Overtime Costs

You’ll almost certainly have employee overtime as a budget item. As a rule of thumb, you can estimate your overtime at 10% to 15% of your annual payroll budget. Then, divide this figure by 12 to find your monthly overtime cost.

Things can be a little more complicated if your payroll tends to fluctuate. This is especially true for seasonal businesses. Applying the formula we mentioned previously may not give you an accurate figure. In this case, there are some factors you’ll need to consider, such as:

  • Which workers earn the most overtime
  • Days of the week or seasons when you need extra help/are busiest
  • Positions that tend to accumulate the most overtime
  • Upcoming events that may require you to hire extra help

Employee Benefits

You’ll also need to add your employee benefits to your payroll budget. These typically include 401(k) and health insurance premiums. You can contact your retirement service providers and insurance providers to get the current rates for the year.

Employee Bonuses

Lastly, you’ll also have to account for your employee bonuses when preparing your budget. You can use your previous year’s payroll if you apply performance-based bonuses. Be careful to tag bonuses with the appropriate name. For example, performance-based bonuses should be tagged as such. This ensures that the bonus isn’t accidentally applied to all employees.

Also, remember to include annual bonuses for all employees in your budget.

Step 4: Budget for Employee Deductions

You’ll need to also factor in deductions. This step may vary slightly depending on your business.

Payroll Taxes

Your business has to pay payroll tax, so this is an essential budget item. The taxes can vary from one year to the next, so make sure that you’re up-to-date with the current payroll tax rates.

Some of the items to consider include:

  • Social Security
  • Medicare
  • Withholding
  • Federal Unemployment

You’ll be using an approximate wage tax withheld percentage for this step. You can get this percentage by adding up all your employee tax deductions to get the final figure. Calxa sets this figure to 25%, so you might want to change it before proceeding.

To calculate your withholding liability with Calxa:

  • Go to Budgets & Cashflow -> Cashflow Settings –> Wages & PAYG.
  • Set the wages tax withheld percentage.
  • Choose the PAYG withholding liability account from the dropdown menu.
  • Set the schedule that you use to report and pay your PAYG.

Step 5: Total Your Payroll Budget

It’s now time to calculate your total payroll budget for the payroll period and the year. Be sure to cross-check all the fields you entered to make sure that your information is correct. On Calxa, the process is as easy as hitting Apply Formula to get your payroll budget.

It should look something like this:

Review Your Budget

It’s a good idea to get some feedback before using your newly created payroll budget to make business decisions. Department managers can offer a fresh set of eyes and spot potential inconsistencies that you may have missed.

Compare Your Budget to Projected Earnings

This step can help you get a quick look at your business’s financial health. This is particularly important if you are planning on hiring new employees. Your payroll budget should amount to about 20% of your revenue. While a lower figure may look good on paper, it’s not always a good indicator of your financial health.

A low payroll budget may indicate that you have fewer staff than you need to handle customers properly. On the other hand, a higher figure means that payroll is eating into your profits. You can find out the average payroll percentage for businesses similar to yours. For example, a company pursuing an aggressive expansion plan will naturally have higher payroll expenses than an established one.

Next Steps

With a payroll budget on hand, you are well-positioned to make projections for the future. Probably the most difficult challenge will be sticking to your budget. Just as is the case with personal finances, it’s easy to find a use for the money that isn’t properly allocated.

Make sure that your budget is as comprehensive as possible, accounting for new hires and increased bonuses. Talk to your employees about additional staffing needs and discuss raises and bonuses with department heads. Stick within your budget limits, especially when considering salary adjustments and when distributing bonuses and merit increases.

Finally, be sure to conduct regular payroll reconciliation for every pay period to make your end-year reconciliation smoother and more manageable. It is also a great way to stay up to date on your business’s financial health. If you want more information on the best online payroll services, check out our in-depth reviews and buying guide.

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