How to do a payroll: a step-by-step guide for UK business owners

As a small business owner, you’re no stranger to a challenge. From identifying which business opportunities are worth pursuing, to devising a marketing strategy for your small business and figuring out how to get clients — you’ve done it all, and more.

Now, as your venture takes off and you explore business growth strategies, you might consider expanding your team.

As soon as you start thinking about how to hire employees, you must also think about how to do a payroll. 

Doing payroll yourself is a great way to keep costs down and manage your small business budget — but navigating the legalities and the admin may feel overwhelming.

To help you, we’ve put together this employer-friendly guide. We’ll show you, step by step:

• How to set up payroll for the first time. This is the one-time task of setting up a payroll system for your business.

• How to do a payroll, outlining what is involved in payroll processing and the steps you’ll need to follow every time you pay your employees. 

What is payroll? A definition and overview 

Payroll is the end-to-end process of calculating and paying employees’ wages. It involves:

• Calculating each employees’ gross pay based on their yearly salary or hourly rate, as well as any overtime, bonuses, or commission. 

• Calculating necessary deductions such as income tax, National Insurance Contributions (NICs), and pension. This leaves you with the employees’ net pay (the amount they actually receive).

• Real-Time Information (RTI) reporting — submitting payroll data electronically to HM Revenue and Customs (HMRC). This must be done every time you run payroll, and before you pay your employees.

• Providing each employee with a payslip that shows their earnings and deductions for each pay period.

• Keeping official records of things like employee payments and deductions, any reports and payments you make to HMRC, and employee leave and sickness absences. All records must be kept (and made available to HMRC, if requested) for 3 years. For a full list of what your records should include, visit the official GOV.UK website.

What is PAYE?

PAYE stands for Pay As You Earn. It’s the system operated by the UK government to collect income tax and National Insurance Contributions (NICs) from anyone who is legally employed.

As an employer, it’s your job to register for and operate PAYE as part of your payroll. For each employee, HMRC issues a tax code that tells you how much tax you should deduct from that employee’s gross pay.

This essentially ensures that employees pay their taxes throughout the year, rather than paying a lump sum all in one go.

Why is payroll important?

Getting to grips with payroll is a crucial step in figuring out how to pay employees. It ensures that your staff are paid correctly and on time — which is critical for employee happiness and employee retention. 

Beyond that, doing payroll correctly is one of the legal requirements for starting a small business and running it compliantly (if you’re hiring people, that is). It ensures that all your taxes, National Insurance, and pension contributions are correct, helping you avoid penalties and fines.

Who is legally obliged to do payroll?

We’ve answered the question “What is payroll?” — but how do you know if it’s relevant for your business?

Whether or not you’re required to operate payroll depends on how your business is set up and what types of employment contracts you have in place. 

You must run payroll if:

• You hire full-time, part-time, or temporary employees for your business. Note that you’re still required to do payroll even if you have just one employee.

• You are a sole trader who employs others. Again, you must run payroll even if you only employ one other person. 

• You are setting up a limited company and paying yourself, or any directors, a salary. 

You do not need to run payroll if:

• You are self-employed and do not hire any staff.

• You hire agency workers or freelancers. In the case of agency workers, payroll is handled by the agency, while freelancers are responsible for their own taxes. 

How to set up payroll for the first time (5 steps)

Before figuring out how to do a payroll, you first need to set up your payroll system. This ensures you have everything in place to start paying your employees.

Here’s how to set up payroll for your business:

Step 1: Register as an employer with HMRC

When you first started out, you’ll have gone through the process of how to register a business with the government. Now, in order to hire employees and set up payroll, you need to take the additional step of registering your business as an employer.

You can do this via the HMRC website, at least four weeks before you plan to pay an employee/employees for the first time. 

Following registration, HMRC will issue you a PAYE reference and a PAYE Accounts Office reference, both of which you’ll need to run payroll and make tax deductions. Note that it may take up to 30 business days to receive these details. 

You’ll also get login details for PAYE Online — the online portal you’ll use to manage payments and access employee tax codes.

What’s the difference between a PAYE reference and a PAYE Accounts Office reference?

Step 2: Set up payroll software

If you’re running payroll yourself, you’ll need dedicated payroll software that’s compliant with HMRC’s Real-Time Information (RTI) system.

Payroll software automates the task of calculating employees’ pay and generating payslips, and enables you to submit your reports directly to HMRC. 

Check the GOV.UK website for a list of HMRC-recognised payroll software (including many free options for businesses with fewer than ten employees).

Step 3: Add new employees to your payroll software

For every employee you hire, you’ll need to add them to your payroll software and let HMRC know that they’re working for you.

To do this, you need:

• The employee’s full name and address

• Their gender 

• Date of birth

• National Insurance (NI) number

• Their tax code, as stated on their P45. If an employee doesn’t have a P45, they will need to complete an HMRC starter checklist to establish their tax code.

• Their student loan deduction status (i.e. whether or not they’re repaying a student loan). 

• Employee start date and salary/hourly rate

• Employee bank details

• Any additional information regarding employee benefits and pensions. 

You must have every employee set up in your payroll system. This is a crucial part of small business accounting, ensuring that you can accurately calculate employees’ pay, tax, and National Insurance Contributions for every payment period. 

Step 4: Check if you need to auto-enrol employees into a workplace pension scheme

As an employer in the UK, you are legally obliged to automatically enrol your employees into a pension scheme — and make contributions — for all employees who are over the age of 22, earn £10,000 or more per year, and ordinarily work in the UK.

If that applies to you and your staff, you’ll need to set up pension contributions through your payroll system. 

Step 5: Set up a payroll calendar

Decide how often you’ll run payroll — that is, how often you’ll pay your employees. You might opt for a weekly, bi-weekly, or monthly pay period; it all depends on your cash flow and the nature of your business.

Set specific pay dates and make sure they align with HMRC’s deadlines for Real-Time Information (RTI) submissions (the reports you’ll need to submit every time you run payroll) and payment of taxes. 

We’ve listed key payroll dates and deadlines to be aware of later on in this guide.

When and how often do you need to run payroll?

With your payroll system in place, you’re ready to pay employees. This requires you to run payroll at regular intervals throughout the year.

When and how often you do payroll depends on the pay frequency you’ve set for your business. This is known as the pay period. 

How to calculate your pay period:

If you pay your employees on a weekly basis, each pay period is 7 days long. If payday falls every Friday, the pay period starts on the Saturday of the previous week and ends on the following Friday (payday).

You might opt for a weekly or bi-weekly pay period if you’re focusing on how to run a business where employee hours vary from one week to the next — such as in hospitality, retail, or construction. 

If you pay your employees on a monthly basis, with payday falling on the last working day of each month, the pay period would run from, say, 1st - 30th of the month. 

A monthly pay period is most common if you have salaried employees who work consistent hours, and in industries where financial planning and cash flow management is more stable and predictable. 

When to start the payroll process:

The payroll process usually begins towards the end of each pay period and must be completed before employee payday.

For a weekly pay period with payday every Friday, you’d probably want to start the payroll process on Wednesday.

For a monthly pay period with payday on the last working day of the month — say, the 31st — you’d start the payroll process around the 25th of the month.

You’ve got your payroll system in place, and you’ve determined your pay period. This leaves one more question to consider: What is end-to-end payroll processing and what does it entail?

How to do a payroll: step-by-step instructions 

To show you how to do a payroll, we’ve put together this step-by-step breakdown, detailing exactly what is involved in payroll processing. 

Step 1: Gather and review employee hours and wages for the pay period in question

As you prepare to run payroll (towards the end of the pay period), make sure that all information regarding employee hours and wages is up-to-date in your payroll software. 

Here’s what you might need to do at this stage: 

• For hourly employees, enter the total number of hours worked throughout the pay period

• For salaried employees, enter any paid overtime worked on top of their usual hours

• Enter any sick days taken by each employee during the pay period

• Enter any paid vacation days taken by each employee during the pay period

• If an employee took any unpaid vacation days, you’ll need to update their pay accordingly in your payroll software

• Enter any additional bonuses or commission earned

• Record any changes to employee details that have occurred since the last pay period — such as a wage increase 

Based on this data, the payroll software will calculate each employee’s earnings, deductions, and taxes for the pay period in question — so accuracy is key. 

Step 2: Calculate deductions for the pay period 

Once you’re certain that all employee information is accurate and up-to-date for the pay period, use your payroll software to calculate:

• Income Tax for each employee (based on the employee’s tax code and earnings for the pay period)

• National Insurance Contributions (NICs) — this includes both the employee’s contributions and your contributions as an employer

• Pension contributions (if your employees are enrolled in a pension scheme)

• Other deductions such as student loan repayments

This step determines each employee’s take-home pay, and calculates what payments you need to make to HMRC. 

Step 3: Generate payslips for each employee

You’re required by law to provide all employees with a payslip — and this is easily done with your payroll software.

Each payslip must state the employee’s gross pay (their pay before deductions were made), all deductions that have been made (tax, NI, pension, etc.), and their net pay (the total amount that they take home).

You can issue paper payslips in person or by post, send electronic payslips via email, or provide access to electronic payslips through a secure online portal. 

Note that employees must receive their payslips either on or before payday, no later. 

Step 4: Report payroll to HMRC 

Every time you run payroll, you must submit Real-Time Information (known as RTI reporting) to HMRC. This involves using your payroll software to send a Full Payment Submission (FPS) on or before payday.

Follow the instructions in your chosen payroll software to complete and submit an FPS. You’ll need your PAYE reference to hand (which you’ll have received after you registered as an employer). 

What’s the purpose of an FPS?

The FPS ensures that HMRC has up-to-date records of your employees’ earnings, deductions, and contributions — allowing for real-time adjustments where necessary. 

Note that the information you provide via your Full Payment Submissions must align with your year end accounts to ensure full HMRC compliance and accurate financial reporting. 

Step 5: Pay your employees

This step is pretty straightforward: transfer each employee’s net pay to their bank account on payday. 

For cash only businesses, you might prefer to pay your employees in cash — and you are legally allowed to do so in the UK. Note that you still need to go through all the same steps in the payroll process, including making the necessary tax deductions, issuing employees with a payslip, and submitting an FPS.

If you do pay employees in cash, be diligent about record-keeping. Have them sign something to confirm that they received the cash and their payslip, including details of the amount and the date of payment. This is a crucial part of small business risk management.

Step 6: Pay tax and National Insurance to HMRC 

Based on the data you provided in your Full Payment Submission (FPS), HMRC calculates how much tax, National Insurance, and any other contributions you owe.

This information is available in the next tax month (which starts on the 6th), and you can view it in your HMRC online account from the 10th of the new tax month.

Payments are due by the 22nd of the month, or by the 19th if you’re sending a cheque by post. You’ll find a list of all approved payment methods on the GOV.UK website.

Step 7: Pay pension contributions 

If your employees are enrolled in a workplace pension, the next step is to pay the necessary contributions to your pension provider.

As an employer, you’re responsible for paying both your own contribution and the employee’s (as you previously deducted this amount from their gross pay).

Payment is usually due by the 22nd of each month. Note that you may face penalties for late or incorrect pension contributions.

Key payroll dates and deadlines to be aware of

As you set up payroll for the first time and start running payroll regularly as part of ongoing operations management, be sure to mark the following dates in your diary.

Key takeaways and next steps 

Perhaps you’re exploring small business ideas and planning ahead for how to start a business. Maybe you’re already running a successful venture and are now figuring out how to scale a business. 

It doesn’t matter what stage you’re at. If your business plans involve hiring employees or paying yourself a salary, you must get to grips with how to do a payroll. This is an essential part of bookkeeping for small businesses, ensuring that you:

• Pay your employees correctly and on time

• Operate in a way that’s legally compliant

• Avoid unnecessary penalties 

Now you’re familiar with exactly what is involved in payroll processing and how to do a payroll, here are some next steps to consider. 

Next steps

Before you do anything, it’s important to weigh up the pros and cons of handling payroll yourself.

If you’re keen to save money and plan on keeping your team small, doing your own payroll in-house might be the best option. If that’s your preferred route:

• Do plenty of research (like reading this guide) to make sure you know exactly what’s required of you as an employer.

• Make a list of all the documents and information you’ll need before you start the process of setting up payroll.

• Run through our step-by-step guides for setting up payroll for the first time and, when the time comes, for running payroll and paying your employees. 

If you’re short on time and worried about making mistakes, it may be worth outsourcing payroll to an expert. In that case, your next step is to find a suitable payroll provider. When choosing a provider:

• Focus on those who specialise in small business payroll.

• Make sure that your chosen provider is fully compliant, and well-versed in UK payroll laws and HMRC reporting.

• If possible, get recommendations from your network. If you’ve not yet started with small business networking, look for reviews and testimonials online. 

Whether you choose to manage payroll yourself or outsource it, having the right tools and systems in place is essential. This helps to keep your business running smoothly, ensures employee satisfaction, and sets you up for long-term success.