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Payroll costs refer to all expenses related to compensating the people working for your business, including what you pay them and what it costs to pay them.

Most businesses spend up to 30% of their revenue on payroll costs, making it most companies' single largest expense.

Here's everything you need to know about payroll costs and 5 specific recommendations to trim the fat (such as implementing payroll software or outsourcing the function).

Types of Payroll costs

Payroll costs are:

  • Broken down into direct and indirect costs, and
  • Vary between full-time employees, contractors, and wage earners

Here's a closer look at each of the costs you'll encounter.

Direct Payroll Costs

Direct payroll costs refer to the monetary compensation and additional benefits you give directly to your workers. These make up the biggest chunk of your payroll costs.

Direct payroll costs include:


Salaries are ongoing, fixed amounts you pay to employees regardless of the number of hours they work. Salaries are paid on a regular pay period (ie biweekly).

Hourly Wages

Hourly wages are variable amounts paid to employees based on the number of hours they work. The hourly wage itself is typically a fixed rate and paid on a regular pay period.

Contractor Payments

Contractor payments are amounts paid to non-employees (ie freelancers or agencies) for fulfilling a contractual obligation towards your company. For example, payment for outsourced bookkeeping help from a freelance accountant.

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Benefits refer to the non-monetary items you offer your employees, such as health insurance, paid time off, and wellness programs. Some types of employee benefits are mandatory to provide; others are optionally used to attract and retain talent.


Bonuses refer to additional financial compensation given to an employee, beyond what is contractually owed and expected. Payment of bonuses is at the full discretion of the employer. This is usually a type of performance-based compensation.

Indirect Payroll Costs

Indirect payroll costs refer to the expenses you incur by having workers, that are not sent to the workers.

Indirect payroll costs include:

Payroll Taxes

Payroll taxes are the percentage of your employees' wages you owe the government, which are determined at a national and state level.

Administrative Costs

Administrative expenses encompass the various costs involved in running payroll, facilitating payments, and delivering benefits to your employees.

This includes the cost of administering payroll, tax filing, sending direct deposits, and even the cost of paper checks (if you're part of the 3.6% of businesses that still do that).

Payroll Options to Consider for Small Businesses 

Payroll isn't changing much but the way you manage it can. Here are the most common ways small businesses take care of their payroll process:

1. In-House Payroll Software

Your first option is the simplest: Get payroll software.

Payroll solutions automate calculations, tax withholdings, and pay distribution, making your in-house payroll process simpler to complete on your own.

Most payroll software charges either per employee or in tiers, depending on the number of employees you have; however, not many provide their pricing online so you'll have to inquire directly.

Payroll Software Options

Software NameProsCons
Trinet- Robust payroll
- Detailed reporting
- Variety in benefits packages
- Complex interface
- Lacking customization
- Relatively expensive
ADP TotalSource- Extensive HR support
- Strong legal compliance
- Intuitive interface
- Integration challenges
- Lacking customization
- Relatively expensive
Paycor- Automation
- Compliance managment
- Intuitive interface
- Customization limits
- Lacking advanced features
- Subpar customer support
Here are a few payroll software options that my team and I have reviewed, to give you some ideas of options.

If you don't care much for DIY solutions, the other options may suit you better.

2. Outsourced Payroll Services

You can outsource the work to external providers specializing in payroll processing and tax compliance, reducing your administrative burden while maintaining assurance of legal compliance.

3. Professional Employer Organization (PEO)

A PEO is a firm that small businesses can partner with to outsource employee management tasks, including payroll, benefits, workers' compensation, and compliance.

Contracting a PEO provider is a good option if you'd like to outsource more than just payroll.

4. Accounting Software with Payroll Functionality

Some accounting software options include payroll features as add-ons. This option is best if you'd like to integrate your payroll information within your accounting and financial management systems, without getting into integrations.

5. Manual Payroll

Chances are, this is what you're doing now but I wouldn't recommend continuing this way. Manual payroll is time-consuming, labor-intensive, and prone to errors, even if the payroll is as small as one employee.

It can work for small teams, of course, but you'll likely want to establish a better system soon.

How to Lower Payroll Costs

Generally speaking, you can lower payroll costs by keeping comprehensive oversight on your annual trends and designing systems for efficiency.

But generalities don't help much.

Here are a few other, specific ways to lower payroll costs:

1. Manage Overtime

Overtime can often balloon up into a high payroll cost... but it doesn't have to.

You can lower overtime costs by setting up alerts in your employee scheduling software. When you receive an alert about an employee’s normal working hours ending, try and assign any pending tasks to another staff member to avoid overtime costs.

2. Reduce Turnover and Avoid Overstaffing

If there's too much to do, you invite burnout into your team; if there isn't enough, you end up wasting money on unnecessary new hires. Instead, maintain balance by:

  • Cross-training employees: Don’t jump straight to hiring when you identify a skill gap. Train staff members who can take on the additional workload and have a related skill set.
  • Building relationships with contractors and freelancers: When cross-training isn't practical, you can fall back on your network of contractors and freelancers to fill in the gaps.

3. Use Payroll Software

Software solutions are like 24/7, uber-efficient team members. They'll catch anything that's out of place for you, enabling you to handle things before they become an issue.

For example, you can auto-generate reports that provide a summary and breakdown of payroll costs, highlighting areas of concern or opportunities to cut back spending.

4. Outsource Payroll Processing

If you're short on time or personnel, outsourcing payroll is a simpler alternative. You just pay the service provider to manage all payroll-related tasks on your behalf.

They'll charge you for their services but, when you weigh it against the opportunity cost of your team having to do the work, you'll almost always find that outsourcing saves you money.

5. Automate Routine Tasks

While you don't have control over all employees' workflows, you can still save on payroll by helping to automate recurring tasks. You'd want to approach it this way:

  1. Analyze workflows to identify routine tasks
  2. Audit who performs them and if there's much task variance
  3. Determine what can be reassigned or automated
  4. Implement automated workflows, task reassignments, and software solutions

By looking for low-hanging fruit within your organization, you can tighten up your payroll spend and improve employees' work satisfaction.

Next Steps for Payroll Management

Small business owners and operators typically don't have enough time to tackle payroll themselves. By finding a good payroll system or payroll service provider, you can save money while you improve your operations.

If you work to address messy overtime schedules, employee turnover, and your hiring workflow, you'll find your payroll costs reducing in no time.

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FAQ on Payroll Costs

Here are answers to a few FAQs about payroll costs:

By Finn Bartram

Finn is an editor at People Managing People. He's passionate about growing organizations where people are empowered to continuously improve and genuinely enjoy coming to work. If not at his desk, you can find him playing sports or enjoying the great outdoors.