How To Create A Payroll Budget For Your Business

A payroll budget should include all payroll expenses including employee earnings, benefits costs, contractor payments, payroll taxes, and any other associated costs.

With all these expenses, payroll budgets account for a substantial amount of your business’s outbound cash flow. So, it’s essential to understand how to create a payroll budget and stick with it.

This beginner’s guide to creating a payroll budget explains everything from calculating employee wages to estimating payroll taxes.

Lets’s dive in!

The Benefits Of Creating A Payroll Budget

A business’s payroll budget is a small, but necessary part of its overall operating budget. When your business operates using a payroll budget, it’s easier to maintain a specific payroll percentage and reduce overspending.

The benefits of creating a payroll budget for your business include:

• Supporting Financial Stability: Maintaining and following a payroll budget can help your business avoid overspending on payroll and taking funds away from other essential operating areas.
• Data-Backed Hiring Decisions: Knowing how much you have within your payroll budget can influence hiring decisions, such as offered benefits, salary ranges, and raises.
• Reducing Unnecessary Spending: Creating a payroll budget can help pinpoint unnecessary payroll spending. For example, you may discover that it would save your business money to hire a single full-time employee rather than two part-time employees.
• Supporting Compliance: Accounting for payroll taxes within your payroll budget can help your business allocate and maintain enough funds to cover any payroll tax liabilities.

How Much Of Your Budget Should Go To Payroll?

There is no set payroll percentage that works for every business. Even so, aiming for a specific payroll percentage or amount fails to account for your business’s unique financial picture and staffing needs.

To determine how much of your business budget should go to payroll, you’ll need to perform an in-depth evaluation of your business’s entire budget.

If you’re wondering how much of your business’s budget is currently allocated for payroll, you can use the following formula to calculate your payroll percentage:

(Total Payroll Expenses)/(Gross Revenue) x 100 = Payroll Percentage

For example, a business that brought in $1,000,000 in gross revenue and spent $300,000 on payroll expenses, spends 30% of its gross revenue on payroll.

Once you’ve determined your payroll percentage, you can decide whether it’s too high or too low based on your preferred profit margins and staffing needs.

What Payroll Expenses Should You Budget For?

Your payroll budget should include fixed and variable payroll costs ranging from employee earnings to recruiting expenses.

Generally, fixed payroll costs remain stagnant for a year, while variable payroll costs can fluctuate throughout the year. Here’s a look at which payroll costs fall into the fixed or variable category:

• Fixed Payroll Costs: Annual employer-sponsored benefits plan costs, salaried employee earnings, and payroll taxes
• Variable Payroll Costs: Employer contributions to retirement accounts, contractor payments, overtime, hiring a new employee, raises, bonuses, commissions, etc.

Keep reading for an in-depth explanation of payroll expenses to include in your payroll budget.

Step 1: Choose A Platform For Your Payroll Budget

The platform you use to create your payroll budget will most significantly impact your ability to share the budget and your payroll budget customization options.

Fortunately, you’ll have plenty of software options to choose from when creating a payroll budget. Here’s a look at your payroll budget software options:

• Google Sheets or Excel: Google Sheets and Excel are spreadsheet software famed for their flexibility, support for calculations, and graphing abilities. While Microsoft Excel can be costly for offline use, Google Sheets is free and more easily shared with others.
• Accounting Software: If your business currently uses accounting software, you can utilize the software to view and manage payroll costs. Most accounting software enables users to generate custom reports, so you can tailor reports to suit your business’s needs.
• Payroll Software: If your business currently uses payroll software, generating payroll and benefits cost reports should be as easy as clicking a few buttons. Better yet, if you’re using an integration-friendly payroll software, you may be able to sync your payroll data with your accounting software for a more holistic view of your business’s financial picture.

If you’re not currently using accounting or payroll software, it may be best to use Google Sheets or Excel.

If you opt to use one of these software options in the future, it’s likely that you’ll be able to export your employee compensation data to a payroll or accounting software solution via a .csv file.

Step 2: Gather Wage, Benefits, & Personnel Information

Gathering all wages, benefits, and personnel information for your business will help streamline the payroll budget creation process. You’ll avoid having to stop in the middle of the process just to find a specific piece of information.

Here’s the short list of information you’ll need:

• Personnel Information: You’ll need to gather the names of all your business’s freelance workers and all hourly, salaried, and temporary employees.
• Wage Information: You’ll need to list every employee or contractor’s specific wage information, such as their hourly earnings or annual salary. You’ll also need to note their pay schedules.
• Payroll Tax Rates: Collect the specific rates for payroll taxes, including FUTA, Social Security and Medicare (FICA), and localized income taxes.
• Employee Benefits: From health insurance coverage to mileage reimbursement, whatever benefits you offer your employees should be collected and listed alongside their costs.

Step 3: Choose A Period For Your Payroll Budget

Before calculating payroll expenses, you’ll need to choose a payroll period for which you’ll generate payroll expense data.

It’s most common to calculate payroll costs by week, month, quarter, or year. However, you’re free to choose the period that works best for you and your business.

Whichever period you choose for your payroll budget, be sure to use the same period for all calculations and estimates going forward.

Once you’ve finished a payroll budget for a set period, you can start the process over with a different period to get a variety of payroll budget expense reports.

Step 4: Calculate Total Salaried Employee Earnings

To calculate salaried employee earnings by a specific period, simply take their gross annual earnings and divide it by the number of days, weeks, months, quarters, or another specific time period per year.

For example, you’ll use 365 days, 52 weeks, 12 months, or four quarters per year, in the following salary calculation:

• (Annual Gross Income)/(Time Periods Per Year) = Salaried Employee Earnings By Period

As an example, let’s calculate the monthly wages of an employee whose gross annual income is $50,000. In action, the equation would look like this:

• $50,000/12 = $4,166 per month

In this example, the employee grosses $4,166 per month before taxes.

Step 5: Calculate Total Hourly Employee Earnings

To calculate hourly employee earnings by a specific period, start with the employee’s hourly wage and multiply it by the number of hours you expect the employee to work.

As a start, full-time employees typically work eight hours per day, five days a week.

• (Gross Hourly Income) x (Expected Hours Per Period) = Total Hourly Employee Earnings Per Period

Using an example of a full-time employee earning $15 per hour, we’ll determine their gross earnings per 40-hour work week. Using the hourly employee earnings calculation, the equation works out to the following:

• $15 x 40 = $600

In this example, the employee grosses $600 per week.

Step 6: Calculate Payroll Taxes

Payroll taxes depend on how much you pay your employees, so you’ll need wage and earnings totals for all hourly and salaried employees to budget for payroll taxes.

As payroll taxes include multiple different taxes and rates, it’s best to maintain separate line items for each individual tax to keep things organized. Here’s a look at the current payroll taxes and their rates:

• Social Security Tax: The current social security tax sits at 6.2% for employers and 6.2% for employees withheld throughout the year. This tax only applies to earnings up to $147,000. Social security tax is considered a Federal Insurance Contribution tax or a FICA tax.
• Medicare Tax: The current Medicare tax rate is 1.45% for employers and 1.45% for employees. Medicare tax is also considered a Federal Insurance Contribution tax or a FICA tax.
• Federal Unemployment Taxes (FUTA taxes): The current 6% FUTA tax rate is applied to the first $7,000 paid to an employee per year.
• State Unemployment Insurance: State unemployment insurance varies by location, so you’ll need to find your state’s unemployment insurance rate.
• State and Local Income Tax: State and local income taxes vary by location, but they’ll need to be withheld throughout the year. Most, but not all states or localities impose an income tax.

To learn how to estimate payroll taxes, you’ll need to start with your business’s nonexempt employee wages from a specific period and apply each payroll tax rate to each employee’s gross wage. You can use the following equation:

(Gross Employee Earnings Per Time Period) X (Payroll Tax Rate Expressed As A Decimal) = Payroll Tax Liability

As an example, let’s find the Social Security tax liability for an employee whose gross monthly earnings total to $3,000. The equation would look like this:

$3,000 x .062 = $186

In this example, an employer would owe $186 in Social Security taxes per month for this employee.

Step 7: Calculate Employee Benefits Costs

Payroll expenses aren’t limited to the wages your employees or contractors earn.

In fact, the most recent data from the Bureau of Labor Statistics shows that wages make up just 68.8% of employer compensation costs. Benefits costs make up the remaining 31.2%.

While your business’s employee compensation costs may not break down this way, it’s essential to calculate your business’s total benefits costs as a part of your payroll budget.

To calculate total employee benefits costs, simply add together all the employee benefits costs your business paid in a given time period.

Be sure to use the same period you used to gather your employee’s wages, so if you calculated monthly gross earnings for your employees, calculate monthly benefits costs now.

Employee benefits costs include:

• Health insurance benefits
• Life insurance
• Paid time off (PTO)
• Retirement plan contributions
• Supplemental pay (think: bonuses, shift differentials, overtime, etc)
• State and federal unemployment insurance
• Medicare
• Social security
• Employee reimbursements
• Workers’ compensation

Compensation cost totals vary from business to business but estimating these costs can help you build a more accurate payroll budget.

Step 8: Add A Budget Buffer For Unpredictable Payroll Costs

There are plenty of unpredictable payroll costs to consider when creating your payroll budget. Most unpredictable payroll costs tend to do with the hiring and termination of employees or contractors.

For example, you may need to match a salary offer that one of your employees received if you want to retain their talent.

The federal, state, or local payroll tax rates may increase. You could lose an employee and need to dole out an unexpected severance check.

A payroll budget buffer can help your business easily manage unexpected costs or at least reduce their financial impact.

The amount you should use for your payroll budget cushion depends on how much you have to spare and the unpredictable costs your business may face.

Step 9: Customize & Total Your Business’s Payroll Budget

Before totaling your business’s payroll expenses, take the time to customize your payroll budget.

Customizing your business’s payroll budget provides you with the opportunity to address any expense that isn’t directly related to employee wages, benefits, or taxes. Moreover, you can adapt the budget to better adapt to your business’s unique financial needs.

For example, if your business hires seasonal workers, your payroll budget may take some jumps during the year.

Or perhaps, the wildly high gas prices have caused your business’s travel reimbursement costs to increase substantially. Additionally, you may decide that paying for a payroll software solution is a part of your business’s payroll budget, rather than a business expense.

Whatever the reason, customizing your business’s budget will improve its accuracy once you’ve totaled all your expenses.

After adding the totals for your salaried employees’ gross wages, hourly employees’ gross wages, payroll tax costs, benefits costs, and any other miscellaneous payroll costs you’ll have completed your payroll budget. Congrats!

Step 10: Regularly Review & Update Your Payroll Budget

A payroll budget is only useful if you actually stick to it, so you’ll need to keep an eye on your payroll and overall business budget.

Set a regular interval at which to review and update your payroll budget as needed. Ideally, you’ll want to review your payroll budget on a monthly basis, at a minimum.

Final Tips For How To Stick With Your Payroll Budget

When it comes to finance management, creating a budget is only half the battle. The other half of the battle is actually sticking with your payroll budget. The best way to stick with your payroll budget is to strike a delicate balance between strict adherence and adaptability.

You want to try to be as strict as possible when it comes to adhering to your payroll budget, but also remain adaptable to keep up with any unexpected changes. That’s why having a budget buffer or cushion is essential, the buffer helps your roll with the punches without breaking the bank.

That said, an accurate payroll budget that you can stick to starts with the creation of a comprehensive business budget that includes all your business’s expenses. If you’re new to business budgeting, check out our beginners’ guide on how to create a budget for your small business for a step-by-step guide to creating a business budget from startup costs to expense management.

Payroll Budget FAQS