An Introduction to Payroll Systems

by John DuBois, Demand Media
The payroll system a company chooses often depends on its size and processing capacity.


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Payroll consists of the process by which a business pays its employees for work performed during a specific period. A payroll system allows businesses to follow a set series of processes in order to make timely, correct payments in compliance with government regulations. A payroll system may be manual or computerized and handled in-house or outsourced to another provider.

Payroll Process Overview

The payroll process typically includes calculating employee pay, recording payroll transactions and determining and paying payroll taxes. A company must have in place a timekeeping system that accurately reflects the hours put in by nonexempt employees as well as the regular salary payments for exempt workers. Employers typically withhold federal income tax from employee earnings; at the end of the year, they must report all wages, tips and other compensation paid. Companies also must withhold Social Security and Medicare contributions from employees' wages and pay a matching amount.


Some smaller businesses conduct their payroll using a manual system. While inexpensive, this method may increase the chances of errors and could prove time-consuming for companies with more than a few employees. With a computerized system, the employer can utilize payroll software to process its payroll on-site. Some larger companies can afford the computer systems and staff to process payroll on their own. Because they spread their costs over a large workforce, they experience lower per-check expenses than smaller firms.


Outsourcing takes place when a business hires a third-party payroll service provider to process its payroll. Such firms typically can handle all aspects of the payroll cycle as well as other reporting services. With an external system, the employer sends payroll data to a service provider to process payments for the upcoming payday. This data includes hours worked as well as benefits, taxes and withholding information. Online payroll service providers offer companies the ability to manage employee payroll accounts and create reports online. However, a company that outsources its payroll to a third-party provider always should review its output for errors to avoid punishment by regulatory agencies should a mistake occur.


Some businesses utilize a hybrid method that takes advantage of elements from both in-house and outsourced payroll systems. This allows employers to split the payroll functions between themselves and the vendor, keeping outsourcing costs lower and allowing for more internal control over payroll data. Typically businesses using the hybrid method calculate pay and distribute paychecks themselves while having the third-party payroll service handle tax filings, direct deposits and the actual printing of the checks.

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