Payroll Process: A complete guide for small business owners

A woman running a payroll process for her small business

Payroll is the process of paying employees. Running payroll consists of calculating employee earnings and factoring out federal and payroll related taxes. The term payroll can also refer to:

  • A business’s financial records of employees
  • The distribution of employee pay
  • Annual records of employee wages

Payroll can be a business’s greatest overhead expense as this process is complicated. Understanding each component of payroll may help you gain a better understanding of your business finances and it can help ensure you remain compliant with the relevant laws.

Steps for processing payroll

1. Collect data

When you hire a new employee you need to collect their payroll information on a Tax File Number (TFN) declaration form. Employers must withhold amounts for taxes and may withhold money to pay for employee benefits and deductions.

2. Calculate net pay

The employee’s net pay is their gross pay minus tax withholdings and deductions. Unlike in some other countries, the medicare levy and student loan repayments are generally included in the PAYG withholding tax amount calculation.

3. Issue payments

You must pay the employee’s net pay via direct deposit within the relevant time frame as specified by the local law.

4. Report taxes

The regularity on which you report your PAYG withholdings is based on your classification as either a small, medium or large PAYG remitter. Therefore, you may be required to submit monthly, quarterly, or annually via Business Activity Statement (BAS) or Instalment Activity Statement (IAS). In addition to this, as part of the normal payroll process, you will be required to lodge Single Touch Payroll reports as you complete each pay run.

5. Withhold and pay taxes

You must forward all taxes and deductions to the relevant authorities, superannuation funds, and other benefits providers.

Essential payroll components

There are many components in the payroll process. We’ve broken down each component into three categories: employee information, salaries and wages, and deductions.

1. Employee information

Before paying employees, they’ll need to give you some information. First, they need to complete a Tax File Number (TFN) declaration. All employees should complete this form as soon as they commence employment with you. This form provides information on an employee’s tax file number and whether or not they are claiming the tax-free threshold or have any debt repayments relating to HELP, VSL, FS, SSL or TSL. The form also includes the employee’s personal information, such as their name, address, date of birth and basis of employment. All of this information will help you process payroll and distribute employee pay.

2. Salaries and wages

The second category is an employee’s pay. It can be an annual salary or an hourly wage. Salaried employees earn a fixed amount per pay period, while wage-earners, or hourly employees, earn an hourly rate. An employee’s payslip may show their gross pay, time worked, overtime pay, benefits contributions and reimbursements, additional income, and net pay.

Gross pay

Gross pay is the total dollar amount you pay to a worker before subtracting deductions. Gross pay is what a worker makes “pre-tax” or “before taxes.”

Employee time

Employee time refers to the number of hours an employee worked in a pay period. Most businesses require hourly employees to track time. However, some salaried employees may also track time if they earn overtime pay.

Overtime pay

Employees may be entitled to overtime pay once they have worked in excess of their agreed ordinary hours, as outlined in the relevant award or agreement under which the employee may be paid. It is common for employment contracts to include a clause that an employee may be expected to work “reasonable overtime” at no extra cost to the employer and without overtime rates. Overtime is when an employee works extra time. It can include work done beyond their ordinary hours of work. The Award establishes what is considered “reasonable overtime”, the overtime rates, and when the rates are applied. The overtime rates may also vary amongst the different awards. Fair Work Australia is the body that oversees and monitors compliance with workplace laws.

Benefits contributions and reimbursements

Benefits are contributions you might provide to your employees. The most common types of benefits include health insurance, superannuation and paid leave. Reimbursements are when the employee is reimbursed for an out-of-pocket work-related expense or expense which the employer has agreed to pay for.

Additional income (Backpay, commissions, and bonuses)

Additional income may apply to service workers, salespeople, and anyone eligible for bonuses. The most common types of additional income include tips, commissions earned on sales, and bonuses. When payment for back payments, commissions and bonuses are made, these payments are taxed using Schedule 5.

 Net pay

After you subtract all deductions, the remaining amount is the employee’s net pay. It’s also called “take-home pay.” Net pay is the amount employees receive on payday.

3. Deductions

Deductions are any amount removed from an employee’s pay for tax or other purposes. Common deductions include payroll withholding taxes, salary sacrifice, union fees and child support garnishments.

Payroll withholdings

This type of deduction primarily refers to income taxes. The employee’s TFN details in conjunction with the income tax thresholds determine how much you should withhold for income taxes, Medicare levy and debt repayments. Generally, the Medicare levy and the debt repayments are incorporated with the income tax component and one figure is deducted from the Gross Wages as a PAYG withholding amount.

Wage garnishments

Wage garnishment is not a common deduction method but is applied in particular situations. Employees who have their wages garnished usually do so under a court order.

  • Some types of garnishments include (but are not limited to)
  • Child support payments
  • Centrelink repayments

The amount to be withheld will depend on the court order and can only be applied once the Protected Earnings Amount has been reached.

Salary sacrifice deductions

Salary sacrifice is a pre-tax amount sacrificed from Gross Wages to reduce the taxable wages. This amount is withheld and remitted on behalf of the employee to the beneficiary – whether it be to the bank for a mortgage, superannuation fund for an employee’s additional contribution or the like.

Other deductions

Other deductions may include health insurance costs, post-tax superannuation contributions, life insurance, workplace giving or other fringe benefits. Unlike benefit contributions, these benefits have a cost for employees in exchange for a service or coverage.

How to calculate payroll

Although there are many components to payroll, not all of them apply to your business. Keep in mind that your business and your local laws may affect how you calculate payroll.

1. Calculate your employee’s gross pay

You can determine an employee’s gross pay using their pay rate and your scheduled pay periods. Most businesses will pay employees on a schedule. Most commonly, pay periods are weekly, fortnightly, or monthly.


To calculate an hourly employee’s gross pay, multiply their hours worked in the pay period by their hourly pay rate. The formula follows:

Hourly rate x total hours worked in the pay period = gross pay

Let’s look at an example. Say an employee makes $15 an hour. Their employer pays them every two weeks. The employee worked 35 hours the first week and 30 hours the second week for a total of 65 hours for the pay period. So the employee’s gross pay is $975.


To calculate a salaried employee’s gross pay, divide their annual salary by the number of pay periods in the year. The formula follows:

Yearly salary/number of pay periods in year = gross pay

Let’s look at an example. An employee makes $60,000 a year. Their company pays employees every two weeks for a total of 26 pay periods. So the employee’s gross pay is $2,307.69.

2. Make pre-tax deductions

After determining gross pay, you’ll need to factor out deductions. These are tax deductions, but other pre-tax deductions may also apply.

Some common pre-tax deductions include:

  • Salary sacrifice superannuation
  • Workplace giving
  • Other salary sacrifice pre-tax deductions

3. Deduct taxes

Once you make pre-tax deductions, the remaining pay is taxed. To calculate PAYG withholding tax you can use the ATO tax calculators. You will report the amount withheld on the Monthly/Quarterly or Annual activity statement.

Deduct the calculated amount from the employee’s gross pay. After that comes superannuation and deductions.

The business submits both the employee’s and the company’s superannuation contributions to the superannuation funds within the timeframes dictated by the ATO or the relevant award under which the employee is paid. Whilst the ATO has minimum quarterly contribution requirements, the award may stipulate monthly contributions.

For example, say an employee earned $1,120 in gross pay for the latest pay period. To calculate the employee’s PAYG withholding using the calculator, answer the relevant questions and enter the amount. The tax withheld is $204. Deduct this amount from the gross pay to arrive at a Net pay of $916 before any other deductions. A superannuation of 10% is accrued and to be submitted to the relevant superannuation fund (along with all the accumulated superannuation) on a quarterly basis.

4. Make voluntary deductions

Once you make an employee’s pre-tax and tax deductions, the next step is to make any other post-tax deductions from the remaining wages. These may include:

  • Employee post-tax superannuation contributions
  • Some health insurance plans
  • Wage garnishments
  • Union dues

5. Determine the employee’s net pay

After all taxes and deductions, the remaining amount is the employee’s net pay. Net pay is how much the employee will take home on payday.

Payroll best practices

1. Know your tax filing dates

You should file your payroll report to the ATO via Single Touch Payroll once each payroll has been finalised. In addition, you will report on either a monthly (21 days after the end of each month) or Quarterly (28 days after the end of quarter) basis via your activity statement for the Gross Wages and PAYG withheld from those wages.

2. Avoid including freelancers and independent contractors in your payroll process

Typically, running payroll only applies to paying employees. When processing payroll, the tax burden is split evenly between employer and employee. However, independent contractors and freelancers are responsible for all their own taxes and benefits. However, it is critical that you determine whether or not they are deemed to be an employee.

As the business that pays a contractor, you are purchasing their service. Lumping in contractors and freelancers into your payroll process may complicate your records. Instead, contractor or freelancer payments should be classified as business expenses. Please note however that some contractors may request voluntary withholdings for PAYG from their payment.

3. Maintain accurate records for payroll

All businesses are required to maintain detailed payroll records. Accurate recordkeeping can protect your business in the event of an audit. The ATO and FWA require businesses to retain payroll records for a period of seven years.

4. Understand how to classify employees

The ATO has set out guidelines to determine whether you are hiring an employee or contractor. Some contractors, those paid mostly for their labour, may also be deemed to be employees for superannuation purposes. Your employees may be classified as being employed on a

  • Full-Time basis (38 hours)
  • Part-Time basis (less than 38 hours but set number of hours per week)
  • Casual basis (ad hoc number of hours)
  • Labour hire basis (worker contracted with Labour Hire Agency) or

Superannuation Income stream basis (Super Provider making super income stream payments)

Ways to process payroll

Now that you understand some of the ins and outs of payroll, it’s time to run payroll. There are several ways for you to process your payroll. You have a choice of:

  • Manually processing your payroll
  • Outsourcing your payroll to
  • An Accountant
  • A BAS Agent or Bookkeeper
  • A payroll service provider; or
  • Utilising payroll software

1. Manual payroll

Manual, do-it-yourself payroll is a common choice for many small businesses, but the process can be time-consuming. You’ll have to calculate everything by hand, keep track of records, and file your taxes. Not to mention retaining & keeping those records safe and secure for a period of 7 years which is going to take up a lot of storage space. Payroll can be a complicated process and making mistakes can be costly. Doing your payroll manually may not be the best long-term payroll solution these days.

2. Outsource payroll

You may outsource payroll to an Accountant, Bookkeeping firm, BAS Agent firm or payroll bureau. Paying someone to run your payroll will free up some of your time and having an outsourced payroll specialist allows you to rest easier, knowing that you have experts on your side. Keep in mind that outsourcing payroll or hiring an in-house accountant can be expensive, not to mention that accessing payroll reports when and if you need them may not be instantaneous.

3. Payroll software

In some cases, payroll software is cheaper than hiring someone and can help you save time when processing payroll. The right payroll service software will let you access and run payroll from anywhere. Other benefits of payroll software include

  • Digitised payroll records and automated recordkeeping
  • Automated tax deductions and alerts for filing dates
  • Automated wage calculations and payday alerts
  • Access to employee data and reports at any time

Making your way through payroll

Payroll can be complicated and time-consuming, but you don’t have to do it alone. No matter how you run your payroll, understanding the basics can help you track business finances. As labour costs are usually the largest business expense for any business, running your payroll correctly is a necessity for your small business’s health and success.

QuickBooks offers a choice of secure payroll accounting solutions that are Single Touch Payroll (STP) Phase 2 compliant. QuickBooks’ Standard Payroll subscription offers a robust solution for businesses that require fast and non-complex payroll processing, whilst QuickBooks’ Advanced Payroll subscription caters for more complex payroll requirements such as rosters and employee agreements. Find out more about QuickBooks Payroll Software powered by Employment Hero.


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