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Mar 29, 2023 Drew Schildwachter

4 Steps to Creating the Optimal Payroll Budget

4 Steps to Creating the Optimal Payroll Budget

A warm sunny day in the middle of winter is a pleasant surprise.

Looking at your business account and seeing a negative balance is not.

Has that ever happened to you? You think you’ve got enough to pay your employees, taxes, and other business expenses, but you didn’t account for _____.

There is another way. The best businesses are built on accurate forecasting and budgeting. You can limit or at least prepare for surprises and even free up your budget for exciting opportunities.

Considering payroll is one of your most significant expenses, it makes sense to start here.

This guide will outline the steps for creating a robust payroll budget, including calculating wages, taxes, and benefits, so you can get on top of your finances and focus on planning for growth.

The Importance of a Payroll Budget

Look at a payroll budget just like a financial plan. Even if you don’t know the exact numbers, you must plan for the costs of paying employees, including salaries, wages, bonuses, taxes, and benefits.

Without a plan, you won’t know if you have sufficient funds to pay employees on time and in full. Also, if you want to make changes, like giving high-performing employees raises, you need to know where that money is coming from.

The same goes for expanding your team.

From a tax perspective, forecasting the costs of payroll and other deductions ensures you set aside enough money to cover them. It’s also easier to budget for benefits.

For most small businesses, the most significant expense is payroll.

To create a payroll budget, think of it as a living document. This isn’t a ‘create and forget about it’ exercise. Finances fluctuate month to month and quarter to quarter.

Keeping a keen eye on your budget can help take the stress out of payroll.

A solid payroll budget allows you to plan year-to-year and make data-backed decisions about staffing, compensation, and benefits. Think of the cost savings you can make if you know where your money is going.

Using data to plan for growth is a smart move.

Step 1: Determine the Number of Employees and Their Pay Rate

Step 2: Calculate Taxes

Step 3: Budget for Benefits

Step 4: Review and Adjust Your Budget


1. Determine the Number of Employees and Their Pay Rates

Start with the people that matter most in your budget, your employees. Make a list of all current employees and their job positions, including yours (hopefully, you’re paying yourself!)

Ensure you include permanent employees, part-time employees, 1099 contractors, and hourly workers. If you pay them, they go into your calculations.

You’ll need to factor in your payroll schedule here. For example, if you pay employees on a bi-weekly schedule, you’ll have different costs compared to a monthly schedule.

Your schedule also affects payroll taxes and benefits.

Calculate the total cost for each person on your payroll depending on your company’s size and structure. You could do this by position or itemize costs for each employee if you have a smaller team.


Estimate Overtime

As part of budgeting for wages, take overtime into account. Of course, this is different for every business, as some jobs require more overtime than others.

Think seasonal fluctuations or new product launches. It’s an additional expense to budget for.

Often, overtime is calculated at a rate of time-and-a-half for each hour worked over a specific threshold, say forty hours per week.

To budget for overtime pay, look at historical data and projected workload to calculate costs.

Remember that you must comply with the Fair Labor Standards Act (FLSA) and state overtime laws, which are often stricter. Some employees are exempt from overtime laws.


Plan for Bonuses

Some companies want to reward employees for meeting specific performance targets. If you decide to do the same, you’ll need to plan for it.

This is another instance where creating a budget helps you forecast. Knowing you have the money to pay bonuses is better than hoping you can pay bonuses this year.

If you clearly communicate the criteria employees need to meet, you incentivize them to show up differently.

Rewarding them for hard work and their contribution to your company’s success with bonuses helps retain top talent.


2. Calculate Taxes

All small businesses must calculate and file payroll taxes. You’ll need to withhold taxes from your employees’ paychecks. They include federal taxes, Social Security taxes, and Medicare taxes.

Related: Are Payroll Taxes Deductible? 3 Top Things You Need to Know

Rates fluctuate, sometimes yearly, so research and calculate withholding rates for the current year.

The current rates are:

  • Federal Unemployment: 6% on the first $7,000 of each employee’s pay
  • Social Security: 6.2% of each employee’s pay
  • Medicare: 1.45% of each employee’s pay
  • Additional Medicare (for employees earning over $200,000): 0.9%


You can take the hassle out of calculating and filing taxes by partnering with a payroll provider. At ConnectPay, we ensure you’re compliant and guarantee that we’ll file your taxes without errors and on time.


3. Budget for Benefits

Some benefits are optional, while others are mandatory. In the majority of states, you must cover workers’ compensation insurance. Voluntary benefits include health insurance, retirement plans, and paid time off (PTO).

The pressure is on you to supply diverse benefits packages to employees if you want to retain top talent. To offer the best benefits, you’ll need to budget for them.

Benefits that are most important to modern employees include

  • Flexible working
  • Professional and career development benefits
  • Wellness and preventive care health benefits
  • Financial benefits
  • Family-friendly benefits

We can connect you with a trusted local expert if you have queries about workers’ comp and benefits plans. Take advantage of our Connected Model.


4. Review and Adjust Your Budget

We said earlier that your payroll budget is a living document. You’ll want to review it regularly to ensure it’s accurate and up to date.

  • Review last year’s expenses: Was there an increase in overtime or a spike in healthcare costs?
  • Compare your expenses to your budget: Did you go over budget? Why?
  • Find opportunities to reduce costs: Are you overpaying for benefits? What about insurance?
  • Communicate: Keep your team in the loop about changes to your payroll budget and how it might affect them.


You’ll also need to make adjustments as necessary to reflect changes in employee pay rates, taxes, or benefits.

Finally, keep accurate records of payroll expenses, taxes, and employee information.

The law doesn’t require you to, but if you keep records for at least three years, you’ll be able to compare reports and budgets and look for gaps and opportunities.

Should You use Payroll Software to Help?

Yes! For small businesses, using payroll software or outsourcing payroll can help them easily create and stay on top of a payroll budget. Getting this time back is invaluable.


  • Automate calculations, such as tax withholding, benefits deductions, and overtime pay.
  • Organize and keep track of all employee information and payroll-related data in one place.
  • Automate the calculation of taxes and deductions so that all federal and state labor laws are met. Some software includes features such as automated compliance updates to keep businesses on top of new rules.
  • Streamline payroll budgeting by automating many of the calculations and record-keeping processes. Plus, most software providers offer subscription-based pricing so businesses can pay only for what they need.
  • Generate detailed reports, including pay stubs, pay history, and summaries. This is helpful in budgeting as it can give you an overview of where the money is going and to what and which employees.
  • Increase the accuracy of payroll budgeting by providing real-time information about employee hours worked, pay rates, and deductions. This can help to identify discrepancies and errors and make corrections.


Beyond the Payroll Budget: Run Your Payroll with Ease 

An accurate payroll budget ensures you pay employees on time and in full.

And knowing how much cash you have flowing in and out of your business gives you the flexibility to invest in other areas knowing you’ve covered one of your most significant expenses.

At ConnectPay, we believe payroll should be simple and hassle-free. We work with small businesses to help streamline payroll and connect them with experts in 401ks, Workers’ Comp, and more.

You can easily create an accurate payroll budget with automated tax processing and filing, pre-tax benefits, and personalized support.

Want to discover more about the best way to run payroll? Download the free Connected Guide to Small Business Payroll and save yourself time and money.

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Published by Drew Schildwachter March 29, 2023