How to pay employees: a complete guide for small business owners

Perhaps you’re thinking about hiring staff to support you with everyday operations management. Or maybe you’re considering expanding your team as you explore business growth strategies. Either way, the question of how to pay employees is an important one.

As you transition from solo entrepreneur to employer, you must make sure that you’re paying employees fairly, correctly, on time, and in a way that’s legally compliant.

In this guide, you’ll find everything you need to know about how to pay employees in a small business (UK) — broken down into nine practical steps.

How to pay employees (step-by-step)

Understanding how to pay employees goes beyond simply issuing wages and payslips. There are several key factors to consider — such as payment type, method, and frequency — as well as legal and administrative requirements to fulfil. Follow these nine steps to ensure a smooth and compliant employee payment process. 

1. Determine pay type

The first step is to determine what payment type works best for your business — and for the employees you intend to hire.

There are two main payment types to consider here: time-related and performance-related.

What is time-related pay?

Time-related pay is where employees are paid based on the hours they work, such as a fixed hourly rate or a yearly salary.

This payment type makes most sense if you’re focusing on small business ideas that require regular and consistent hours from staff.

If you’re running a café, for example, you’d likely pay your baristas an hourly rate. Or say you’re exploring creative ways to make money and running your own design agency. If you hired a permanent, in-house designer to support you, you’d offer them a fixed yearly salary.

With time-related pay, employees earn a consistent wage regardless of their performance. 

What is performance-related pay?

With performance-related pay, an employee’s compensation is partly determined by their performance.

This is useful if you want to incentivise your employees to meet specific targets, or if you’re considering how to motivate employees in a particularly challenging role.

If you’re focusing on how to get clients, for example, you might hire sales professionals and offer a bonus or commission based on the number of sales closed.

Performance-related pay is usually combined with time-related pay, offering employees a fixed base salary plus the opportunity to earn more if they do well.

2. Calculate a fair wage

As you navigate the process of how to hire employees and consider the topic of pay, you’ve probably found yourself wondering: how do employers decide how much to pay employees?

Just as you’d weigh up different pricing strategies to determine how to price a product or how to price a service, you must also think carefully about how much to pay your staff. Here are some steps to help you:

Understand the legal requirements around pay

When first getting your venture off the ground, you’ll have spent some time researching the legal requirements for starting a small business. Now the same goes for paying your employees.

As an employer in the UK, you must comply with minimum wage laws. Most workers are entitled to the National Minimum Wage, with the exact amount varying depending on the employee’s age and employment status. Workers aged 21 and over must be paid at least the National Living Wage.

Make sure you’re up-to-date on the latest requirements, and use that figure as a starting point to determine employee pay. 

Consider each employee’s skills and experience 

Next, think about the specific role(s) you’re hiring for — and the skills and experience required. If you’re looking for a highly skilled pastry chef, for example, or a senior hair stylist with lots of industry experience, you’ll need to offer a higher salary than you would for junior roles.

Do your research to understand the current market. Sites like Glassdoor, Indeed, and Payscale provide average salary data for different job titles and seniority levels. It’s also worth checking job boards, as many companies display a pay range when hiring.

Aim to offer competitive pay that’s in line with market averages (without putting too much strain on your small business budget). This will help you to attract great candidates and foster long-term employee retention. 

Create a salary benchmarking document

Use your research to create a salary benchmarking document. In a simple spreadsheet, list all the job titles you want to hire for. Then set out clear pay bands for each role based on experience and seniority.

This ensures that all employees are paid fairly, which is crucial for building trust and creating a positive working environment.

It also helps to encourage professional development and set clear expectations in terms of pay progression. If you’re using performance management techniques such as setting SMART goals and conducting regular performance reviews, your salary benchmarking document can be used to align pay increases with employee growth.

3. Consider deductions, contributions, holiday, and sick pay

When determining how to pay employees, you must also think about deductions, contributions, and employee benefits such as holiday and sick pay.

These factors will vary depending on the types of employment contracts you offer. Full-time employees are automatically entitled to statutory sick pay and paid annual leave, for example, whereas casual or zero-hours contract workers may only be eligible for sick pay if certain other criteria are met.

As an employer, you also need to make the necessary deductions when paying employees. This includes things like income tax, National Insurance contributions, and workplace pensions. We’ll cover this topic in more detail in steps 7 and 8 (setting up payroll and running payroll).

4. Determine pay frequency

The next step is to decide how often you’ll pay your employees. Whether you opt for a weekly, bi-weekly, or monthly pay period all depends on the nature of your business and your operating cash flow.

If your employees work consistent hours with a fixed salary, and in businesses where cash flow management is more stable and predictable, a monthly pay period is most common.

But, if you’re focusing on how to run a business in, say, the hospitality sector where staff hours can vary from one week to the next, it might make more sense to pay your employees weekly or bi-weekly.

Note that you must set and adhere to a consistent pay day; every Friday, for example, or the last working day of each month. Besides being a legal requirement, this provides necessary stability for your staff. 

5. Choose a payment method

Now for the practical matter of how to pay employees. If you’ve got just one or two employees on your books, you might opt for a manual bank transfer each month.

However, many UK employers choose to automate the process using BACS (Bankers’ Automated Clearing System). This is similar to a regular transfer, but it allows you to process multiple payments at once and schedule them in advance.

For cash only businesses, paying your employees in cash may be the best option. Of course, you’ll still need to go through the same payroll process and make all the necessary tax deductions. And, for the sake of small business risk management, be sure to keep thorough records of all cash payments and have employees sign upon receipt.

6. Register as an employer with HMRC

In order to pay employees, you must register as an employer with HMRC. If you’re setting up a limited company with 1-9 directors (or have already done so), you can register as an employer via the official GOV.UK website.

For all other types of business, you’ll need to fill out an online questionnaire (available via the same link) to find out how to register as an employer.

You must complete the employer registration process before the first payday. Upon successful registration, you’ll receive your PAYE reference number — which you need in order to run payroll.

7. Set up payroll software 

Payroll is the official process all employers must follow when paying employees. It involves calculating employee wages and deductions for each pay period, submitting payroll data to HMRC, and paying staff each payday.

If you want to keep your small business expenses down, you can run payroll yourself. If you don’t want the administrative burden (and have the budget available), you can outsource payroll to a specialist provider.

To do your own payroll, you need dedicated payroll software. Check the GOV.UK website for a list of government-approved options (including free software for businesses with fewer than 10 employees).

Every time you hire a new employee, you’ll add them to your chosen payroll software — entering details such as their National Insurance number, tax code, and salary or hourly rate. Based on the data you provide, the software will automatically calculate each employee’s earnings and necessary deductions for every pay period.

8. Pay employees correctly and on time (run payroll) 

You’ve successfully registered as an employer, set up payroll software, and hopefully hired some great people for your team. Now for the final piece in the puzzle of how to pay employees: running payroll.

Here’s how to do a payroll:

• Make sure all employee information is up-to-date in your payroll software. If you’re paying your staff an hourly rate, enter the hours they’ve worked for the pay period in question, as well as any additional bonuses or commission earned. At the same time, enter any paid annual leave or sick leave.

• Calculate each employee’s gross pay and net pay. As long as all employee data is correct, your payroll software will automatically work out the necessary deductions (National Insurance, income tax, pension, etc.) and their take-home pay.

• Generate payslips. As an employer, you’re legally obliged to provide each employee with a payslip that states their gross pay, all deductions that have been made, and their net pay. Payslips must be issued on or before payday.

• Report payroll to HMRC. Every time you run payroll, you must submit a Full Payment Submission (FPS) to HMRC, either on or before payday. You can do this using your payroll software. 

• Pay your employees. Last but not least, pay your staff using your chosen payment method (bank transfer, BACS, or cash). It goes without saying that all employees must be paid accurately and on time — and, if you’ve got your payroll system set up correctly, this should be the easy part.

9. Keep accurate records 

Keep detailed documentation of all employee payments — including payslips, tax deductions, National Insurance contributions, and pensions. Your payroll software will automatically provide a record of such data, but it’s your responsibility to ensure that everything is accurate and up-to-date.

Maintaining comprehensive payroll records is crucial for legal compliance and good financial management. It contributes to efficient bookkeeping for small businesses, ensures you’re well-prepared for financial audits, and makes it easier to submit your year end accounts.

Key takeaways and next steps

No matter what kind of business opportunities you’re focusing on or how many people you plan on hiring, getting to grips with employee pay is essential. Understanding how to pay employees — and setting up an efficient payroll process — ensures that you:

• Pay your employees fairly, correctly, and on time

• Are legally compliant, meeting all HMRC requirements and deadlines

• Foster a positive workplace culture where employees feel valued

Next steps

You now have an end-to-end process you can follow to successfully navigate the challenge of employee pay. Before you get started, here are some additional tips and next steps to guide you. 

1. Plan well ahead. It’s crucial that you understand all the ins and outs of how to pay employees before you start hiring — and that you have the necessary tools and systems in place well ahead of time. When you register as an employer with HMRC, for example, it may take up to 30 days to receive your PAYE reference number (which you need in order to do payroll). Try to be as organised as possible and get everything in order before your employees start. 

2. Seek expert advice. If you’re ever unsure about anything related to employee pay, or if you get stuck anywhere in the process of setting up or running payroll, consult a payroll expert. Even honest or unintentional mistakes may result in penalties, so err on the side of caution and accuracy.

3. Stay informed on legal requirements. As an employer, it’s your responsibility to ensure that your payroll practices remain compliant — so make sure you’re up-to-date with employment laws and HMRC guidelines. Check the GOV.UK website for the latest information regarding National Minimum Wage and the National Living Wage, for example, as well as updates on statutory sick pay, holiday entitlement, and any changes in tax regulations.