How to Do Payroll: The Ultimate Guide for Your Small Business

Our guide on how to do payroll will help you choose the right approach for your business— whether that's handling it yourself, investing in payroll software, or outsourcing to professionals. 

After all, not every payroll story has a happy ending. According to an analysis by EY, the average company only achieves 80% payroll accuracy and requires 15 corrections per pay period. These mistakes aren't just admin headaches—they cost small businesses thousands in corrections and can damage employee trust.

We'll draw on insights from dozens of successful small business owners who've learned these lessons the hard way, so you don't have to.

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What are the steps of payroll?

Whether you plan to handle payroll yourself, use software, or work with an outsourced provider, you'll need to understand these fundamental steps because, in the end, you're responsible for accuracy and compliance. These steps form the backbone of any payroll process—regardless of your chosen method.

1. Collect and verify employee information.

The first step seems simple enough: gather employee information. Missing or incorrect details here can spiral into major problems later.

"In our early days, we had constant confusion about overtime calculations and bonus structures," admits Josh Qian, COO of Best Online Cabinets. "Employees would come to me frustrated, wondering why their paychecks didn't match their expectations." 

Accurate information is crucial for calculating an employee's paycheck correctly. The solution? Creating crystal-clear documentation from day one.

Here's what you need to nail down for each employee so you can run your payroll with ease:

• The basics: W-4s, I-9s, and direct deposit info
• Pay details: base rate, overtime rules, and bonus structures
• Benefits choices: what's being deducted and when
• Tax stuff: state and local requirements

2. Set a payroll schedule.

When should you pay your employees? It sounds like a simple question, but get it wrong and you'll face some pretty significant consequences. 

Just ask Ray Lauzums, owner of Poggers, who learned: "Delaying payroll under any circumstances, even during tight cash flow periods, can erode trust and hurt morale." A consistent payroll schedule where you pay employees on time is vital for maintaining a happy team.

Think about:

• What's normal in your industry (retail often does weekly).
• Your business's cash flow cycle (when customers pay vs. when bills are due).
• What your state requires.

3. Track and calculate hours.

This is one of the main ways small businesses stumble. Between overtime, tips, and various shift premiums, there are plenty of opportunities for errors. 

Greg Arnold, General Manager of KitchenMania, puts it bluntly: "Make sure to run missing punch reports before you even think about starting payroll calculations. If your timekeeping records aren't accurate, you'll run into massive headaches."

An employee's gross pay is calculated from the number of hours worked multiplied by their hourly rate, which means inaccurate timekeeping directly affects payroll.

Key areas to monitor:

• Regular hours worked
• Overtime calculations
• Tips and commissions
• Paid time off
• Holiday pay

4. Calculate deductions and payroll taxes.

Understanding payroll taxes isn’t the most exciting thing in the world, but getting them wrong is expensive. The IRS can charge penalties up to 100% of unpaid payroll taxes, plus interest. Accurately calculating state income tax is the key to avoiding these penalties.

"Payroll becomes complex–considering that every modification in the tax law or overtime regulations makes doing payroll manually highly prone to mistakes," explains Lucas Botzen, HR Expert at Rivermate. "Without specific software and support, doing payroll becomes incredibly risky." 

His team now uses automated systems to ensure compliance with ever-changing regulations.

What you need to calculate each pay period:

• Federal income tax withholding
• Social Security and Medicare (FICA)
• State and local taxes
• Health insurance premiums
• Retirement contributions

5. Process and verify payments to pay employees on time.

Payment processing isn't just about sending money—it's about getting it right every time. "Don't push payroll to the finish line," warns Steve Shen of All 4 Kids. 

"During peak seasons like Thanksgiving and Christmas, we always process payroll a few days early. Proper timing helps retain employee trust and keeps morale high." Processing paychecks accurately and on time also helps your business comply with tax obligations and avoid payroll-related issues.

Here are some essential payment steps to follow:

• Review all calculations before processing.
• Send direct deposits or print checks.
• Distribute detailed pay stubs.
• Document all transactions.
• Keep records of payment confirmations.

How can you do payroll?

You know what goes into the payroll process, but now comes the big question: What's the best way for your business to handle it? 

You've got three main options, and choosing between them isn't just about cost—it's about finding what works for your time, your team size, and your comfort level with payroll tasks. After all, payroll services can vary in complexity and are meant to suit different business sizes.

Let's look at each approach—doing it yourself, using payroll software, or outsourcing completely—to help you find the right fit. We'll cover what's involved, who each method works best for, and what you need to know before making your choice. You’ll also find an expanded checklist of questions to ask yourself in your quest.

DIY payroll

Doing payroll yourself is when you’re in charge of everything—from tracking hours to filing taxes. While it puts you in complete control and saves money upfront, you'll need to dedicate significant time to learning tax laws and staying on top of calculations. 

Additionally, processing payroll manually means spending time gathering accurate employee information, calculating pay and withholdings correctly, and staying updated on tax regulations. This method makes the most sense when you're just starting out with a handful of employees and straightforward pay structures.

Payroll software

Think of this as your digital payroll assistant. Modern tools like Homebase automate the number-crunching and tax filing while keeping you in the driver's seat for important decisions.

You get the best of both worlds: Payroll software handles the complex math and compliance updates, while you maintain visibility into your payroll process. Perfect for growing businesses that want to scale efficiently without drowning in spreadsheets.

Outsourcing payroll

This is the method where you bring in the professionals to take payroll completely off your plate. While it's typically the priciest option, it buys you peace of mind and frees up valuable time to focus on growing your business. 

This approach shines for larger operations, especially those dealing with multiple states or complex pay structures that require the touch of an expert.

Consider a hybrid approach.

Most successful small businesses actually use a combination of human oversight (DIY or outsourced) and software automation—and for good reason. You keep control of critical decisions and maintain visibility into your payroll, while automation handles the complex calculations and compliance requirements.

As Martin Gasparian, owner of Maison Law, explains: "If you're doing your own payroll, you'll need to stay updated on tax laws and regulations while maintaining accurate records on employee hours, wages, overtime, and deductions. But that doesn't mean doing it all manually." 

James Wilkinson, CEO of Balance One Supplements, agrees: "When we first started, we worked with spreadsheets manually, which was error-prone and time-consuming. Discovering payroll software saved us thousands of hours while maintaining accuracy."

This hybrid approach works especially well with platforms like Homebase, where you can easily review and adjust calculations, manually approve time cards, and customize pay rules, but let the software handle the heavy lifting of tax calculations, direct deposits, and record-keeping. It's the sweet spot between maintaining control and saving time.

How to do payroll yourself (DIY process)

Running payroll yourself isn't just about crunching numbers—it's about understanding what you're getting into and whether it's the right fit for your business.

What DIY payroll really involves:

• Setting up your tax accounts and maintaining compliance with federal, state, and local authorities.
• Creating a reliable system for tracking employee hours, overtime, and paid time off.
• Managing payroll taxes, including calculating, withholding, and making timely deposits.
• Handling year-end processes like W-2 preparation and tax filing.
• Staying current with changing tax rates and labor laws.

Why most small businesses evolve beyond pure DIY

Steve Shen of All 4 Kids learned this lesson firsthand: "In our early days we were able to do payroll manually, but as we expanded it became increasingly impossible to escape from errors." 

Lucas Botzen of Rivermate agrees: "Without specific software and support, doing payroll becomes hard. Every modification in tax law or overtime regulations makes doing payroll manually highly prone to costly mistakes."

That's why many small businesses are choosing a middle ground: Maintaining oversight while using tools like Homebase to handle the complex calculations, tax filings, and record-keeping automatically. You keep control where you want it, but don't have to worry about spreadsheet formulas or tax table updates.

How to do payroll using payroll software

Running payroll with software transforms time-consuming manual tasks into automated workflows. Modern payroll platforms handle everything from time tracking to tax filing, dramatically reducing the risk of errors while saving you hours each pay period.

What payroll software handles

• Automated time tracking and overtime calculations
• Tax withholdings and compliance updates
• Direct deposit processing and pay stub generation
• Employee self-service portals for documents and information
• Integrated scheduling and labor cost tracking
• Year-end tax form preparation (W-2s, 1099s)
• Automatic payroll tax filing and payments

How to run payroll with Homebase

Running payroll involves dozens of moving parts, complex calculations, and constant deadline pressure. One missed detail or calculation error can spiral into hours of corrections—or worse, compliance issues. That's why smart small businesses are switching to payroll software like Homebase that's built specifically for their needs.

Instead of juggling spreadsheets, tax tables, and compliance updates, Homebase handles the heavy lifting automatically. From tracking overtime to filing taxes, the system remembers every step so you don't have to. Here's exactly how it works:

1. Set up your digital system.

Getting started with Homebase means saying goodbye to manual timesheets and complicated spreadsheets. Think about your current process: manually tracking employee hours, calculating different pay rates, and figuring out overtime. Now imagine all of that happening automatically. 

With Homebase, you'll enter your employee information and pay rates once, set up your overtime rules and PTO policies, and connect your bank account for direct deposits. After this initial setup, the system takes care of the rest—tracking every clock-in, break, and overtime hour automatically.

2. Let the system track time.

This is where the magic happens. Instead of chasing down paper timesheets or manually entering hours, Homebase tracks everything automatically. Your employees clock in and out using the app, and their hours are instantly recorded. 

The system even sends alerts before anyone hits overtime and automatically calculates different pay rates for different roles. No more end-of-week scrambles to figure out who worked when—it's all there, accurate to the minute, ready for your review.

3. Review and approve timesheets.

When it's time to run payroll, you'll find all your timesheet data already organized and ready for review. Unlike manual systems where you'd spend hours cross-checking schedules and time cards, Homebase presents everything in a clear dashboard. You can see exactly when employees clocked in, what breaks they took, and any overtime worked. 

Need to make an adjustment? Just click to edit. Once you're satisfied, approve the timesheets with a single click, and they're locked to prevent unauthorized changes.

4. Let Homebase handle calculations and compliance.

Here's where you really save time—and avoid costly mistakes. Homebase automatically calculates all wages, including overtime and different pay rates. It figures out the correct tax withholdings for each employee and ensures you're compliant with federal, state, and local labor laws. 

The system processes direct deposits, handles tax payments, and even takes care of year-end forms like W-2s and 1099s. Instead of worrying about tax deadlines or compliance updates, you can focus on running your business.

How to do payroll using HR outsourcing.

Sometimes the smartest business decision is knowing when to hand over complex tasks to the experts. HR outsourcing means partnering with professional services that handle everything from payroll processing to compliance management, freeing you to focus on growing your business.

What HR outsourcing takes care of

• Complete payroll processing and tax filing
• Employee benefits administration
• HR compliance management
• Workplace policy development
• Risk management and safety programs
• Employee relations support

What it costs

Most HR outsourcing services charge either per employee per month (typically $150-$250) or a percentage of your total payroll (usually 3-8%). While this is higher than DIY or software options, many businesses find the comprehensive support is absolutely worth the investment.

A middle-ground solution

Before jumping into full HR outsourcing, consider starting with an integrated platform like Homebase. Our payroll software offers many of the same benefits—automated payroll, compliance updates, and HR tools—at a fraction of the cost. You'll get professional-level support while maintaining control of your processes.

Best practices for payroll compliance and efficiency from small businesses

Small business owners who've learned payroll lessons the hard way spoke with us to share their hard-earned, top tips for getting it right:

1. Don't push payroll to the last minute.

Timing can make or break your payroll process. Andrew Pickett, founder of Andrew Pickett Law, emphasizes this crucial point: "Missing payroll deadlines can lead to disgruntled employees and penalties. Set reminders and automate processes to ensure timely payments."

A structured, proactive approach to payroll timing helps you keep your employees happy and keeps you ahead of compliance requirements.

2. Prioritize clear documentation from day one.

Documentation can prevent most of your payroll headaches before they start. Joan Denizot, owner of Body Ready, learned this through experience: "At first, I underestimated the importance of meticulous record-keeping. Now, I ensure that all hours worked, deductions, and tax payments are well-documented. This practice has proven invaluable during audits and when resolving any payroll questions."

Clear, detailed documentation isn't just about staying organized—it's your best defense against confusion and compliance issues.

3. Run regular payroll audits.

Catching errors early can save you from major complications later. Martin Gasparian of Maison Law, emphasizes the importance of regular checks: "The average business makes around 15 mistakes during payroll periods, costing them huge amounts in corrections. For many small businesses, these mistakes can be devastating, having lasting impacts."

Making time for regular payroll audits isn't just good practice—it's essential protection for your business's financial health.

4. Handle mistakes with urgency.

Speed matters when payroll problems arise. Andrew Bates, owner of Bates Electric, learned this firsthand: "You'll try your best, but be aware that you will make mistakes, and it's best to move to fix them efficiently rather than dwell on them. Payroll can be high-pressure because people are relying on you and expecting a perfect delivery, so be prepared to communicate clearly and quickly with any employees affected by mistakes. In most cases, clear communication, respect, and a quick resolution are enough to placate your people."

Swift action combined with transparent communication turns a potential payroll crisis into an opportunity to strengthen employee trust.

5. Set up a backup system.

Even the most organized payroll system needs a backup plan. This became clear to Guillaume Drew, owner of Or & Zon, when a key team member unexpectedly took leave: "A backup payroll contact should never be disregarded. In case of unforeseen personal leave or business interruptions, having a second team member who is acquainted with how payroll works sustains the workflow."

Having a trained backup ensures your payroll process keeps running smoothly, no matter what unexpected challenges arise.

Make the right payroll choice for your small business.

Whether you're just starting out or looking to improve your existing payroll process, the key is finding an approach that matches your business's current needs while supporting future growth.

DIY payroll works best when you just have a handful of employees and a straightforward pay structure. While it gives you complete control and can save money initially, most businesses quickly find that the time investment and compliance risks outweigh the cost savings—especially as they grow beyond a few employees.

That's where payroll software like Homebase comes in, offering the perfect middle ground. You maintain visibility and control while automating the complex calculations, tax filings, and compliance updates that often trip up small businesses. And if your needs eventually grow to require full HR outsourcing, you'll have the systems and data in place for a smooth transition.

Ready to find your payroll sweet spot? Try Homebase's free payroll tools today →