Payroll for small business: how it works and costs

Published Friday 20 March 2026

Table of contents

• What does payroll mean for small business?
• How does payroll work?
• What's involved in payroll compliance?
• What are payroll deductions?
• Reporting to HMRC
• What to look for in payroll software
• Payroll options for small business
• How to choose the right payroll solution
• How much does payroll cost for small businesses?
• Simplify payroll with the right tools
• FAQs on payroll for small businesses

Key takeaways

• Choose payroll software that automatically calculates tax and National Insurance, integrates with HMRC for direct submissions, and generates detailed payslips to save time and reduce compliance errors.
• Submit your Full Payment Submission (FPS) to HMRC on or before each payday and transfer collected taxes by the monthly or quarterly deadline to avoid penalties of up to 100% of underpaid tax.
• Keep detailed payroll records for at least three years, as HMRC may investigate up to five additional years back if inaccuracies are found during compliance checks.
• Consider outsourcing payroll to service providers or accountants when your team grows beyond 10 employees or when payroll complexity with variable hours and multiple pay rates takes too much of your time.

What does payroll mean for small business?

Payroll is the process of paying your employees and making the required deductions from their wages. It involves two core responsibilities:

• Paying accurately: Give employees the right amount at the right time, every time, in line with their contract and employment law
• Deducting correctly: Take the right amounts for tax, National Insurance, pensions, and other obligations

There are many rules around payroll. You need to comply with government requirements to keep your employees paid correctly and avoid penalties. HMRC can raise penalties of up to 100% of any underpaid tax.

How does payroll work?

Payroll repeats every time you pay your employees, whether that's weekly, fortnightly, or monthly. Here's how the process typically flows:

1. Collect time and attendance data: Gather hours worked, overtime, sick leave, and holiday taken for each employee.
2. Calculate gross pay: Work out what each employee has earned before deductions, including any bonuses, commission, or allowances.
3. Make deductions: Subtract income tax, National Insurance, pension contributions, student loan repayments, and any other required amounts.
4. Calculate net pay: The amount left after deductions is what your employee takes home.
5. Pay your employees: Transfer wages to their bank accounts on the agreed payday.
6. Report to HMRC: Submit your Full Payment Submission (FPS) on or before each payday.
7. Pay HMRC: Transfer the tax and National Insurance you've collected by the monthly or quarterly deadline.

Most payroll software automates steps 2 to 6, leaving you to collect the time data and make the payments.

What's involved in payroll compliance?

Payroll compliance means meeting all the legal requirements for paying employees and reporting to HMRC. To stay compliant, you must:

• Make accurate payments and deductions: Calculate wages, tax, National Insurance, and pension contributions correctly
• Provide detailed payslips: Show employees exactly what you've paid and deducted
• File and pay taxes on time: Submit reports and payments to HMRC by the deadlines
• Pay deductions to the right places: Send pension contributions and other amounts to the correct organisations
• Keep payroll records: Hold onto records for at least three years. If inaccuracies are found, HMRC may go back up to five more years in an investigation.

Consider applying payroll numbers to your employees. This helps with managing records and ensuring the right money goes to the right person.

What are payroll deductions?

Payroll deductions are amounts you take from your employees' gross pay before paying them. There are two types:

Mandatory deductions you must make:

• Income tax: Collected through PAYE based on their tax code
• National Insurance: Contributions for state benefits and pensions
• Student loan repayments: If HMRC notifies you an employee has one, apply the correct thresholds and rates for their plan type.
• Court-ordered payments: Such as child maintenance

Voluntary deductions your employee may request:

• Workplace pension contributions: Beyond the minimum auto-enrolment amount
• Private healthcare: If you offer a scheme
• Charitable donations: Through payroll giving schemes

You can learn more about these deductions, including the order you make them, in our guide to hiring staff.

Reporting to HMRC

As an employer, you collect taxes from your employees on behalf of HMRC. You need to report what you've collected and pay it over on schedule.

Every payday, you send HMRC a Full Payment Submission (FPS) using your payroll software. The FPS includes:

• Employee details: Names, National Insurance numbers, and tax codes
• Pay information: Gross pay, taxable pay, and hours worked
• Deductions made: Income tax, National Insurance, student loan repayments, and pension contributions

You can report employee expenses and benefits through your payroll. Alternatively, you can report them separately at the end of the financial year using a P11D form. The introduction of mandatory payrolling of benefits in kind (BIK) has been delayed to April 2027.

What to look for in payroll software

Good payroll software should save you time, reduce errors, and keep you compliant with HMRC. Here are the key features to look for:

Essential features:

• Automatic tax calculations: Works out income tax, National Insurance, and pension contributions based on current rates and employee tax codes.
• HMRC integration: Submits your Full Payment Submission (FPS) and Employer Payment Summary (EPS) directly to HMRC.
• Payslip generation: Creates detailed payslips for each employee automatically.
• Auto-enrolment support: Manages workplace pension compliance and contributions.

Useful extras:

• Employee self-service: Lets staff view payslips, update details, and request leave independently.
• Accounting software integration: Syncs payroll data with your accounts so you don't have to enter it twice.
• Multiple pay schedules: Handles weekly, fortnightly, and monthly pay runs if you need them.
• Year-end reporting: Produces P60s and handles year-end submissions to HMRC.

Questions to ask before choosing:

• Does it handle your current number of employees, with room to grow?
• Is it HMRC-recognised for online submissions?
• How much support is included if something goes wrong?

Payroll options for small business

The more employees you have, the more complex it usually is to process payroll. A mix of hourly wages, salaries, contractors, commission, overtime, and leave entitlements means your payroll can be different every time you run it.

Here are your main options for handling small business payroll:

• Pen and paper or spreadsheets: Suits businesses with just a handful of employees. However, HMRC requires specific formats for reporting, so you may need additional tools.
• DIY payroll software: Calculates pay and deductions automatically and fills out tax forms. You'll still need to make the actual payments yourself, but the admin is much simpler.
• Payroll service providers: Outsource your payroll to specialists who handle everything from calculations to HMRC submissions. Some do it all, while others help with specific tasks.
• Accountants and bookkeepers: Handle payroll alongside your other financial tasks. Many offer payroll services. Check out the Xero advisor directory to find one.

How to choose the right payroll solution

The right payroll solution depends on your business size, complexity, and how much time you want to spend on admin. Here's how to match your situation to the best option:

Choose DIY payroll software if:

• You have a small, straightforward team with similar pay arrangements
• You're comfortable using software and have time to run payroll yourself
• You want to keep costs low and stay in control

Choose a payroll service provider if:

• Your payroll is complex, with variable hours, multiple pay rates, or frequent changes
• You'd rather hand off the responsibility to experts
• You want someone else to handle HMRC submissions and stay on top of rule changes

Choose an accountant or bookkeeper if:

• You already work with one for your accounts and want everything in one place
• You need advice on tax efficiency and employment costs alongside payroll
• You value having a trusted advisor who knows your business

Key questions to ask yourself:

• How many employees do you have, and how often does your payroll change?
• How much time can you realistically spend on payroll each month?
• What's your budget for payroll software or services?
• Do you need help with compliance, or just the calculations?

How much does payroll cost for small businesses?

Payroll costs for small businesses typically range from free to around £15 per employee per month, depending on whether you use software or outsource to a provider.

Here's what you can expect to pay:

• Free or low-cost software: Basic payroll tools start from £0–£5 per month, though you may pay extra for features like HMRC submissions or pension integration.
• Mid-range payroll software: Full-featured options typically cost £5–£15 per employee per month, including tax calculations, payslips, and HMRC reporting.
• Payroll service providers: Outsourced payroll usually costs £3–£10 per employee per payrun, plus a monthly base fee of £20–£50.
• Accountants and bookkeepers: Rates vary widely, but expect to pay £50–£200 per month for payroll as part of a broader service package.

Factors that influence payroll costs

Several things affect how much you'll pay:

• Number of employees: More staff usually means higher costs, though some providers offer volume discounts.
• Payroll frequency: Running payroll weekly costs more than monthly because there are more payruns to process.
• Complexity: Variable hours, multiple pay rates, and benefits add to the workload and cost.
• Level of service: Basic software is cheaper than full-service providers who handle everything for you.
• Add-on features: Employee self-service portals, HR tools, and advanced reporting often cost extra.

Simplify payroll with the right tools

Payroll doesn't have to be complicated. Once you understand the basics of pay, deductions, and HMRC reporting, the right tools can handle most of the heavy lifting for you.

Good payroll software calculates pay automatically, fills out tax forms, and helps you stay compliant without manual effort. It saves time, reduces errors, and lets you focus on running your business.

Ready to streamline your payroll? Get one month free and explore payroll software designed for small businesses.

FAQs on payroll for small businesses

Common questions small business owners ask about payroll.

Can I do payroll without an accountant?

Yes. You can run payroll yourself using payroll software. It calculates pay, makes deductions, and submits reports to HMRC automatically. Many small business owners manage payroll in-house, especially with fewer than ten employees.

How much does payroll cost for a small business?

Payroll software typically costs £0–£15 per employee per month, while outsourced payroll services range from £3–£10 per employee per payrun plus a monthly base fee. Your total cost depends on the number of employees, payroll frequency, and level of service you choose.

Which payroll software is best for small businesses?

The best payroll software depends on your needs, but look for HMRC-recognised software that calculates tax automatically, generates payslips, and handles pension auto-enrolment. Integration with your accounting software and employee self-service features is a useful extra.

Can I do payroll for free?

Some basic payroll tools are free, but they often lack features like direct HMRC submissions or pension management. For example, HMRC provides free Basic PAYE Tools software for businesses with fewer than ten employees. Free options work for very simple payrolls, but most small businesses benefit from paid software that helps them comply automatically.

How do I know when to outsource payroll?

Consider outsourcing when payroll takes too much of your time, your team is growing, or you're worried about failing to comply. If you're spending hours each month on payroll admin or struggling to keep up with rule changes, a payroll service or accountant can help.