What Are the Steps of a Payroll Cycle?

If you're a business owner or human resources professional, you know that paying your employees accurately and on time is crucial for maintaining employee satisfaction and keeping your business running smoothly.

The payroll cycle is a series of steps that make sure your employees get paid on time and that you stay on top of your financial obligations. While it sounds simple, the payroll cycle is actually a complex process that requires your full attention to detail and accuracy.

What Is Payroll Processing?

Payroll processing is the process of calculating employee compensation, including salaries, wages, bonuses, and benefits, accurately and on time. The payroll cycle ensures compliance with labor laws and helps maintain employee satisfaction and retention.

The cycle typically involves several stages, such as collecting and reviewing employee data, setting up payroll software, and ensuring everything is accurate and up to date before issuing payments. It also involves post-payroll activities, such as reconciling payroll accounts, preparing payroll tax filings, issuing employee documents (e.g., W-2s), and addressing any errors or discrepancies that may have arisen during payroll processing.

If you’re expanding your business to Mexico and wondering how much your employee payroll would cost, you can use our Mexico payroll calculator to find out. Make sure to also read our post on What Is A Payroll Calculator so you understand how to use it.

Six Steps in the Payroll Cycle

Let's take a look at the steps of a payroll cycle:

1. Get an Employer Identification Number (EIN)

Before beginning the payroll process, make sure you have an EIN and state or local identification number. The government will use these identification numbers to keep track of your business’s payroll taxes and ensure you comply with rules and regulations.

If you don’t have an EIN, you might be able to apply for it online through your country’s government website. If the same is the case for your state or local tax numbers, you can apply for them through your state’s tax or finance department.

1. Collect Employee Tax Information

Once you’ve received your EIN and state and local tax identification numbers, you have to ask your employees to fill out tax forms such as the I-9, W-4, and W-2. The number of tax forms will depend on where your business is operating.

You should also make sure you have the following documents:

• Job Applications: These documents contain employee information, such as their name, pay, and other details.
• Deductions: If your employees are given benefits like a health savings account, health insurance, or a retirement savings plan, you need to withhold the appropriate amounts for these benefits each pay period.

1. Set a Payroll Schedule

After you’ve collected all the tax and personnel information you need, you should establish a payroll schedule. You could opt for monthly, semimonthly, biweekly, or weekly payments.

However, don’t settle on a pay schedule without understanding the pros and cons of each for your business. You don’t want to end up defaulting on your employees’ payroll because that could lead to noncompliance with labor and payment laws, leading to jail time and heavy fines.

Once you’ve chosen a schedule, set up a calendar with paydays to keep track of the days you have to process payroll. Ask your employees for their preferred delivery methods, such as a paper check or direct deposit into their bank account.

1. Determine Gross Pay

Now that you’ve set up your payroll schedule, you should begin the process of calculating each employee’s gross pay. This is the number of hours an employee works in a pay period multiplied by their hourly rate.

To calculate the gross pay, figure out the number of hours an employee worked in a pay period. Also, consider the number of overtime hours the employee has put in. You’ll have to pay a higher rate if the total number of worked hours is more than forty per week.

Let’s look at an example. Say Jake worked sixty hours each week during a monthly pay period. He earns $25 per hour. His pay for the standard forty hours per week is $1,000. When multiplied by four (for the four work weeks in a month), Jake’s monthly payment will be $4,000.

Then, Jake worked twenty additional hours of overtime each week. His overtime pay will be time-and-a-half of his usual pay, which is $37.5 x 80 = $3,000. His gross pay is going to be $7,000 for that month. 

1. Calculate Deductions

Once you’ve determined your employees’ gross pay, you have to gather information from their W-4s and about state, federal, insurance, and benefits requirements to find out their deductions. These can include the following:

• Federal taxes
• Social Security
• States taxes
• Local Taxes
• Medicare
• 401(k) contributions
• Workers’ compensation contributions

1. Deduct Taxes and Issue Paychecks

Now you should subtract each employee’s deductions from their gross pay to get the net pay, which is the amount you’ll pay each employee. You can use a withholding calculator to make the process easier.

Once you’ve established each employee’s net pay, it’s time to pay them. Here are the options you have:

• Direct deposit
• Paper checks
• Mobile wallet
• Prepaid cards
• Cash

The Steps Get Easier Every Time

Here’s something to look forward to—once you get the payroll process nailed down, each cycle will become easier to do. This will leave you and your employees who manage the payroll process with more time to handle other issues and business activities!