Pre-COVID, small businesses represented the vast majority of U.S. employers. While these companies were disproportionately affected by shutdowns, those that stayed open and were able to take advantage of the CARES Act Payroll Protection Program were faced with a mixed blessing: They could keep their workers on, but the payroll process got even more complex.
In fact, for small businesses, payroll is traditionally both one of the biggest operating costs and one of the heaviest administrative burdens, especially for companies that manage payroll manually. And for good reason—mistakes can result in both stiff IRS penalties and unhappy employees.
Frequent changes to tax rules and other regulations make payroll processing even more challenging, especially for small businesses that continue to be impacted by COVID-19. One way to manage the complexity is to use payroll software or services to automate payroll calculations and payments, reduce administrative headaches and increase accuracy.
Small Businesses Employ Many Americans
Small businesses remain the lifeblood of the U.S. economy, even though they face challenges. Employment declined, on average, 27% for firms with fewer than 500 employees and about 28% for firms with fewer than 50 employees between mid-February and mid-April 2020, according to a study by the U.S. National Academy of Science.
The sector began from a place of strength, according to the U.S. Small Business Administration. As of Dec. 2019:
- The 31.7 million companies with fewer than 500 employees represented 99.9% of all U.S. businesses.
- Small businesses employed 60.6 million U.S. workers—47.1% of the private-sector workforce.
- Small businesses accounted for 65% of job growth between 2000 and 2019, creating 10.5 million net new jobs compared with the 5.6 million new jobs created by large businesses.
These firms were buffeted by forces beyond their control, and most had less than a month’s cash in reserve, per McKinsey. Those that survive and return to employment levels comparable to late 2019 will have proven their resilience.
Proceedings of the U.S. National Academy of Sciences: The impact of COVID-19 on small business outcomes and expectations
U.S. Small Business Administration Office of Advocacy: 2020 Small Business Profile (pdf)
U.S. Small Business Administration Office of Advocacy: FAQs (pdf)
McKinsey & Co.: COVID-19’s effect on jobs at small businesses in the United States
Payroll Stats by Industry
Small businesses operate in all sectors of the U.S. economy; the chart below shows the Top 12 sectors with the largest number of small businesses as of 2017, according to the Economic Innovation Group.
Top 12 Small-Business Industries
|Industry||Number of Small Businesses with Employees||Total Number of Employees||Average Number of Employees per Firm|
|Professional, Scientific and Technical Services||807,932||5,190,980||6.4|
|Health Care and Social Assistance||650,689||8,984,159||13.8|
|Accommodation and Food Services||537,443||8,542,661||15.9|
|Administrative and Support and Waste Management and Remediation||343,791||3,754,463||10.9|
|Real Estate and Rental and Leasing||308,106||1,451,546||4.7|
|Finance and Insurance||236,657||1,909,993||8.1|
|Transportation and Warehousing||182,688||1,685,388||9.2|
|Arts, Entertainment, and Recreation||129,287||1,428,531||11|
Source: EIG Small Business Share of Employment by Industry
Businesses involved in healthcare and social assistance, including doctors’ offices and social services, employed the most workers of any sector in 2017—almost 9 million. Companies involved in accommodation and food services, including hotels and restaurants, came in a close second, with 8.5 million workers.
The U.S. Census Bureau Small Business Pulse Survey reports that the five sectors hit hardest by COVID were accommodation and food services, arts and recreation, educational services, health care and manufacturing. Still, many professional services niches held their own, and demand for housing kept construction strong.
Economic Innovation Group: Small Business Share of Employment by Industry
U.S. Census Bureau: Small Business Pulse Survey
Paychecks and Your Employees
Just as small businesses found that cash on hand was key to survival, paying employees accurately and on time is critical. Nearly 70% of employees taking part in a survey by the American Payroll Association said that meeting their financial obligations would be difficult if their paychecks were delayed a week.
The good news is that 93% of employees said their paychecks are always delivered on time—although only 60% are “very certain” that their paycheck deductions and net pay are accurate; a further 27% are “somewhat certain.”
One thing most don’t need to worry about is keeping their paychecks safe: A large majority, 93%, of U.S. employees are paid by direct deposit.
Direct deposit is efficient, and employees can quickly access their money even if they’re working at home or traveling. This is especially important given the rise in the number of remote workers. A Gallup poll found that 62% of employees worked from home during the COVID-19 pandemic, and the majority of them, 59%, said they would prefer to continue working remotely after the pandemic ends.
American Payroll Association: Getting Paid In America Survey
Nacha: How Direct Deposit Works
Gallup: U.S. Workers Discovering Affinity for Remote Work
Wasted Time and Money
Payroll processing is challenging and complex, and it can be time-consuming. Employers must accurately withhold and pay federal, state and local taxes, as well as any deductions for benefits. Adding to that complexity, tax laws frequently change.
No wonder, then, that nearly one quarter of small businesses say payroll taxes are their biggest tax burden, according to the National Small Business Association’s Taxation Survey. About one-third of small businesses surveyed spend more than six hours each month handling payroll internally, while one-third of businesses with five or more employees spend more than six hours per month handling payroll taxes internally.
Changes to employee circumstances continuously create new payroll administrative work. Almost 25% of employees completed new W-4 forms during 2020, per the APA’s Getting Paid in America Survey, and the majority of those workers did so because they wanted to change their tax withholding or their financial circumstances changed.
Fluctuations in employment combined with revenue interruptions can cause serious cash flow problems: More than 60% of small businesses experience fluctuating payroll cash outflows due to changes in employment, according to JPMorgan Chase. Yet only half of small businesses have enough cash to continue operating for more than 15 days if revenue is disrupted, and companies with irregular cash flows are more than twice as likely to be forced to shut down permanently, per Chase.
NSBA: 2018 Small Business Taxation Survey (pdf)
JPMorgan Chase & Co.: A Cash Flow Perspective on the Small Business Sector
Payroll mistakes can be costly, and not just in terms of morale. Companies may face hefty fines for failing to pay workers correctly or paying payroll taxes late.
- In 2019 alone, the IRS levied almost 5 million penalties related to payroll taxes, totaling $13.7 billion.
- One common mistake is misclassifying workers. State-level studies show that 10% to 20% of employers misclassify workers as independent contractors, per the Economic Policy Institute.
Why take that chance? Businesses must pay 50% of Social Security and Medicare taxes for employees, but not for contractors. Non-exempt employees are also entitled to minimum wage and paid overtime. Yet if a business misclassifies workers, it may face penalties as well as owe taxes and potentially additional wages.
IRS: 2019 Data Book (pdf)
Economic Policy Institute: (In)dependent Contractor Misclassification
Automation in Payroll
Managing payroll manually using spreadsheets is labor-intensive, error-prone—and increasingly impractical as the business grows. Small companies can increase accuracy, efficiency and help create a positive employee environment by automating payroll processing using in-house software or an outsourced service.
When choosing a payroll solution, small companies are, of course, concerned with price. But other areas that can make their finance teams more productive include automatic updates as tax laws change and the ability to integrate with the company’s benefits providers, so that payroll deductions go directly to covering those costs.
Besides automation, the payroll cost calculation should weigh managing payroll internally versus outsourcing. Small businesses should also look for an intuitive and secure portal where employees can check their own pay and manage benefits online.
- There are almost 300,000 payroll and bookkeeping services in the United States, according to IBISWorld.
- More than half of small businesses pay an outside firm to prepare their payroll, per the NSBA taxation survey.
- A majority of small businesses in the NSBA’s 2019 Technology & Small Business Survey manage their payrolls online.
- Another IBISWorld report predicts that U.S. sales of HR and payroll software will grow 8.7% in 2020 to reach $10.8 billion. Sales increased by an average of more than 10% annually between 2015 and 2020.
IBISWorld: Payroll & Bookkeeping Services in the US
NSBA: 2019 Technology & Small Business Survey
IBISWorld: HR & Payroll Software in the US
#1 Cloud Accounting
Smart Payroll Moves
Small businesses often start out by using an accounting package and handling payroll manually or with separate payroll and time management systems. However, manual payroll processing is labor-intensive and error-prone. And, using multiple systems for accounting, payroll and time management can make it more difficult to analyze and forecast costs across the business.
Transitioning from multiple accounting and payroll systems to a single integrated software suite generally saves money and makes it easier to analyze costs, as a number of case studies demonstrate.
N&N Moving Supplies, a family-owned company that provides equipment to professional movers, moved its own payroll and accounting needs to NetSuite to better handle business growth. By switching from QuickBooks for accounting and a separate payroll system to NetSuite’s integrated solution, N&N was able to cut payroll processing time by 84%, balance accounts faster and improve accuracy.
When the St. Hope Community Schools added SuitePeople HR and Payroll to its NetSuite solution, it slashed the time needed to process payroll from 15 hours to two hours. Previously, employees were tracking hours and pay rates on spreadsheets.
Finally, Chicago Rubber & Seal, a distributor of parts for marine engines and other products, found that switching from QuickBooks to NetSuite enabled the company to stop using a separate payroll service, saving $150 a month. It was also able to better track cash flow.
As many small companies have learned, payroll can be a complex and time-consuming chore—especially if you handle it manually. Furthermore, the penalties for payroll errors can be severe. However, automating payroll processing can reduce administrative headaches and increase accuracy. Your employees will appreciate the effort.