How to Choose a Payroll Structure, According to Cash Flow

As a small business owner, figuring out the ideal time to pay your employees is a matter of survival. It seems to make sense, then, to choose a payroll structure that corresponds with your cash flow: You have the most money, so you should pay your team when you have cash.

Unfortunately, it’s not quite that simple. Although the premise is grounded in sound logic, the basics of small business bookkeeping don’t allow you as a small business owner to make a choice so seamlessly on how to choose a payroll structure.

There are a few essentials you’ll need to know first about this decision—and understanding the why behind structuring your payroll will help you make even more educated, effective financial decisions as a business owner.

What Came First: the Payroll or the Payroll Structure?

There’s one extremely important thing you have to do how before you payroll structure according to your cash flow. And that’s to choose a payroll schedule in general. One that’s perfect for your business exactly.

If you think about it, choosing a payroll structure entirely according to cash flow is sort of a chicken/egg situation. Of course, cash flow should be a big consideration in when you pay employees. But from the perspective of a bookkeeper, picking a payroll schedule (aka payroll structure) solely based on your cash flow—that’s unconventional.

That’s because the payroll schedule tends to dictate the cash flow, not the other way around.

When Payroll Doesn’t Dictate Cash Flow

Obviously, there are exceptions to the rule.

For instance, if you charge your clients on the first of the month for your services, it makes sense for you to do a monthly payroll right after that because it’s when we’re most flush with cash. (That is, of course, expecting your clients pay on time.)

Next, you might have different employee types that work on different pay structures: hourly, salaried, commission, and piece work, for instance. These are all specific types of employees, and thus expect a different pay dates. A business that typically employees primarily lower wage, hourly workers can’t expect those employees to only get paid on a monthly or bimonthly basis—they face different financial challenges than those of higher-paid, executive-level employees.

→TL;DR (Too Long; Didn’t Read): It’s hard to choose a payroll structure based on cash flow because payroll often dictates cash flow. There are exceptions to the rule, including those with extremely predictable invoicing cycles (as long as your clients pay!).

7 Factors to Consider Before Your Choose Your Payroll Structure

Of course you can choose a payroll structure according to cash flow—you can do a lot of things! But should you? We’d say absolutely not. It’s not a good idea for your business.

Then what requires your attention before you pick your payroll schedule? When figuring out the best time to pay your workers, you can’t just look at cash flow. You have to analyze a number of things before you make your choice:

State Requirements

Before you consider any payroll structure, you need to know  what your state requirements are for payroll schedules. This table from US Department of Labor is an invaluable resource for anyone getting ready to start hiring. It provides some insights on what your state requires.

For example, you can see that Pennsylvania and North Carolina don’t dictate when employers are required to pay employees—which means you can set your payroll structure at your discretion. In Arizona, though, employees are required can be paid twice a month, as long as the paydays are not more than 16 days apart. For clarification, it’s always best to contact your state to make sure you’re in full compliance. (Weekly is always an option!)

You can always pay more frequently, but not less.

Your Break-Even Point

Figuring out how much your business needs to make is  the first step in helping to determine when to hire and how much you can afford to  pay your employees. This break-even template from SCORE can assist you in establishing your existing break even and to create what-if scenarios regarding hiring.

Many forget that an employee that makes $10 per hour will have a total cost of about between $11.25-15 per hour, depending on what sort of benefits are offered.

Cash Flow

Cash flow does still matter!

Your Profit and Loss statement isn’t going to give you the full picture of what you need to be looking at. Make sure you consider your other cash outlays that may not be included in that report, such as business loan payments, sales tax or payroll tax liabilities, plus business credit card payments, owner draws, or any purchases of assets like property, inventory or equipment.

Compliance

What are the overtime requirements? How often will you be required to pay taxes and file returns? Do you have any local or city taxes to consider? Do you have employees working in another state?

Employees’ Details

How many employees will you need? How many hours will each work? Are they going to be hourly, salary, commission? How often are they expecting to be paid? What is appropriate for their job title?

All of this needs to factor into your decision around choosing a payroll system.

Payroll System and Processing

When thinking about your payroll structure, you’ll want to consider who will be creating the paychecks, processing returns and scheduling tax payments. Outsourcing is generally more cost effective and offers peace of mind if you’ve never dealt with payroll.

If you’re more familiar with it, you can consider using a app like Gusto, or a sort of hybrid like QuickBooks Full Service Payroll that allow you to create the paychecks and Intuit manage the tax compliance.

Direct Deposit vs. Paper Checks

As we mentioned earlier, there are some rare situations during which sometimes cash flow can help determine payroll structure. But that the opposite can also be true.

If you issue paper checks, you have no control over when the employee cashes their paychecks, possibly throwing off your cash flow. In this writer’s own experience, one client’s employee would cash all of their paychecks at one time—meaning all four or five, depending on the month, would clear the bank at the same time. This was so unexpected, the client ended up with an overdrawn account the first few months because all of those paychecks were clearing the same time as their sales tax payments and large monthly vendor payments.

By using direct deposit, you can better control your cash flow because you know that all of the paychecks are clearing at the same time—usually two business days before the employee sees the money deposited in their account. If you’re wondering if you can require employees to use direct deposit, don’t worry—you can in many states as long as you meet some simple requirements. If an employee doesn’t have a bank account, you can look into employee paycards. Some payroll apps or providers offer these along with your payroll processing.

→TL;DR: Although you should look at your cash flow, there are other factors to consider when choosing your payroll structure. Make sure you check your state regulations, too—some states mandate more frequent payment than others!

Next, Choose The Best Payroll Schedule for Your Business

Have a handle on how those 7 aspects of your business work? Good. Not we’re on the way to getting you closer to a payroll structure that works for you. The next step is understanding the differences among each type of payroll schedule.

Weekly

You pay your employees every week, for the previous week. A typical weekly payroll  structure pays employees each Friday, for the previous week.

• Example: Sunday through Saturday

Biweekly

Employees are paid every other week, for the previous two weeks. A typically biweekly payroll structure pays employees on a set day following the end of the pay period.

• Example: Pay period runs from Sunday, April 29 through Saturday, May 12 with a pay date of Thursday, May 17

Semi-monthly

Not to be confused with biweekly, this pay schedule is typically the 1st and 15th of the month or 16th and 30th. In other words, there are always only two pay dates per month versus a biweekly that could possibly have three.

• Example: May 3, May 17, and May 31 for pay periods ending April 28, May 12, and May 26, respectively

Monthly

This is payroll that is paid once per month. It isn’t used very often because many states don’t allow it.

A Note on Benefits and Deductions

One more thing to consider is that benefits and deductions are often calculated on a monthly basis. When looking at biweekly vs semi-monthly, you’ll want to manage these carefully. Semi-monthly may be easier because you just divide by two. For bi-weekly, you have to calculate based on the 26 pay periods per year (some years may have 27!).

→TL;DR: The most common schedules for employer payment are weekly, biweekly, and semi-monthly. Monthly usually isn’t used because many states require more frequent payment.

Which Payroll Structure Is Best for Your Business?

Ultimately, you’ll be able to find the best payroll structure for your business by taking stock of your business’s financial health, and, of course, working closely with your bookkeeper. That said, many businesses pick biweekly.

“Biweekly payroll is a good balance between doing the burdensome office work of processing payroll too often—as with, say, weekly payroll—and in not doing it often enough to keep your employees paid without huge delays,” says Cliff Mitchell, CEO of time tracking app Clock Shark. “Although in some industries like construction where certified payroll requirements may mandate weekly payroll, weekly becomes the only option. This means time sheets need to be turned in and processed more frequently, which adds additional work. However, employees often like weekly payroll, as it gets their money to them more quickly.”

Although employees may prefer weekly, many businesses prefer biweekly payroll because the cost to process is cheaper. Companies that offer payroll services, like ADP or Paychex, generally charge each time paychecks are processed. If not using a payroll service, it takes time to add up all those hours and make sure overtime, vacation, sick, or other PTO is recorded correctly.

But don’t—as we’ve said already!—use cash flow patterns as the only factor when you’re evaluating which payroll structure to use. There are too many other factors that you need to examine and analyze. Look at the needs of your business, employees, budget, and more. You’ll find a solution that works for everyone.

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from Fundera Ledger https://www.fundera.com/blog/payroll-structure