Let’s Stop Treating Payroll Like A Back-Office Chore

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Everyone loves to hate payroll. No one pays attention when it works and everyone notices when it breaks. But it has the potential to be so much more for small businesses.

ABC News Australia recently reported that North Canberra Hospital staff were not paid on time after a payroll processing issue. Staff received pay slips, but direct deposits didn’t land in their bank accounts following a file transmission error. Employees and union representatives were quick to respond, criticising the hospital for creating more stress in an already stressful job.

While the hospital is a large employer, the story is a cautionary tale for small business owners who relegate payroll to the back office. Payroll is the first system put in place for a small business and the one that likely drives the bulk of the expenses on the P&L. For employees, it’s the system that gets them paid, but it’s also their regular touchpoint with business operations. It’s where they record time, request PTO, enter and receive tax information, access benefit information, and check for company communications and policies. When it fails, the issue isn’t just operational; it’s emotional and cultural. Payroll sets the tone for employee experience.

Payroll As A Compliance System

Payroll is most well known as a compliance tool. It handles pay calculations, tax withholding, wage reporting, and often includes employee facing compliance processes. It houses the data records and reports used in an audit and it must adapt to changing federal and state laws. It’s this complexity that drives most companies to rely on external vendors for their payroll software.

To complicate matters, an increasing number of small businesses have joined the trend of multi-state employment since the pandemic. A company with remote employees in New Jersey, New York, Pennsylvania, Ohio, California, Texas and Florida may still feel like a founder-led company where everyone knows each other. But, from a payroll compliance perspective, it’s running like a company ten times its size. Thomson Reuters reported in March that remote and hybrid work are increasing multi-state payroll tax compliance risk, including state income tax withholding, unemployment insurance, paid family and medical leave reporting, and employer registration obligations. Employers, not payroll system suppliers, are ultimately responsible for correct withholding and remittance. Mistakes can trigger penalties, amended returns and employee frustration.

For small businesses looking at payroll migration, finding a supplier that is well versed in multi-state compliance and reporting, can handle new state registrations, and can handle both employee and state-driven changes has become table stakes for migration projects. But while compliance is certainly important, it’s not where the true added-value lies.

Payroll As A Management System

Payroll can (and should) be a driver for workforce planning, cash flow management, and profit calculation. Yet few CFOs are involved in defining the business requirements for payroll migration projects. It’s typically relegated to HR or the software provider to drive and the result is a baseline configuration with little to no consideration for business specifics or management reporting.

If it’s set up intentionally, payroll helps tell the story of what is actually happening in the business. Reporting design starts with an understanding of the business itself and then setting the system up to gather the right data, in the right way so the reports produce what the business needs as decision support. Unfortunately, for most small businesses, a payroll migration projects start with a series of software demonstrations where sales people show HR or the office manager how payroll runs and where employees enter data. It’s the wrong way around. Start with an internal discussion of business needs and only then invite vendors to demo who can meet those needs.

Basic questions include geography, employee types, pay frequencies, overtime rules, tips, commissions, bonuses, garnishments, deductions, benefits, PTO, job costing, and general ledger integration. Then spend some time thinking about reporting needs and future opportunities for higher level reporting. It doesn’t matter how big or small the business is, the management questions are similar:

Staffing: Where are we over- or understaffed? Is it creating overtime issues? Do we know when to hire? Are we managing PTO in a way that we don’t have coverage issues?

Labor Costs: What is turnover doing to our overall labor costs? Are we paying our people appropriately? Are our benefits competitive?

Profit: Can we do job costing and tie it to profit analysis? Are we pricing our products / services correctly?

Kate Dadetto, a Senior Consultant with Red Clover HR shared, “I’ve used payroll data and related reporting to create budgets and cost forecasting that help businesses decide which roles they can add and still hit budget targets.”

Imagine a payroll system that could help you answer those questions. It’s possible, but the system needs to be set up for it and the data needs to be clean. As the saying goes in systems migrations, “garbage in, garbage out”.

Time And Attendance Data Is Key

Time and attendance data is often overlooked as a source of operational intelligence in a small business. A good timekeeping process identifies whether overtime is isolated or if there is a structural issue. It can help with hiring and staffing decisions. It shows if staffing and schedules match labor needs and if the same employees are carrying the workload every week. For example, a professional services firm may think they’re profitable until time data shows too many senior employees doing low-margin administrative work. Non-exempt employees are required to track their time, but exempt employees can also track their hours for job costing purposes.

The reporting only works if the data structure and tracking process and output is accurate. If job codes aren’t well designed, if employees don’t report time on the correct job code, and if managers don’t review timecards, then the reports may look great, but they’ll tell the wrong story.

What We Can Learn From Canada

In 2016, Canada introduced a new payroll system, Phoenix. Good idea, bad execution. The system itself wasn’t the primary problem, the data was. And the result was significant payroll issues impacting hundreds of thousands of employees and years of work to correct the problem. In fact, they’re still working on it. So what does the Canadian government have in common with a small business? Different behaviour issues certainly, but same risks. For Canada, audit findings highlighted slow decision making. While small businesses are certainly more agile, they sometimes move too quickly or skip steps in an effort to move through a migration project swiftly. Business owners gloss over business needs and fail to ask who will be responsible for data cleansing and migration. The result is a game of data-hot-potato. The implementation suffers and everyone is unhappy.

Payroll Can Help You Understand Profit

Labor is often one of the largest expenses in the business, but many companies still do not understand labor cost at the level where decisions are made. Good job costing changes that. If job codes are well designed and implemented and communicated, they can help break down labor cost by product or service line, by customer, by location, by department, and so on. When business owners have a solid labor cost report, it can inform decision-making on pricing, staffing, and where to invest company resources for growth. But if employees are not coded correctly or if the general ledger integration is too broad, the data will not support the reporting requirements.

Dadetto continued, “I’ve used payroll data to inform business decisions around [employee] benefits. For example, in one case, we added disability plans and life insurance based on employee compensation data. It made the management conversation so much easier when we had the right data.”

For the CEO of a 150-person company (or the owner of a 15-person business), payroll may still feel like something that belongs to the office manager or HR. But it’s one of the few systems that connects people, time, money and compliance in one place. Payroll may not be glamorous but, when it’s well set up, it can be one of the most useful systems to support leadership decision making and business growth planning. Don’t miss the opportunity to learn from what it’s telling you.