Choosing the Best Payroll Strategy for Your Company

There's an art and a science to figuring out what payroll system works best for your small business. Bi-weekly? Semi-monthly? We'll help you choose.
December 18, 2014

Deciding how often to pay your employees can be just as important for your small business as determining how much to pay them. While at first it may seem like a simple decision, there are a number of factors you need to take into account that can impact employee morale, payroll processing costs and compliance with state and federal regulations.

As you prepare for 2015, let’s take a closer look at several different options you have for paying your people.

1. Standard payroll periods. There are four standard options you can choose for pay periods: weekly, bi-weekly, semi-monthly and monthly. Weekly and monthly are self-explanatory, but there are a few factors to consider when choosing either of these options.

Because they're the most frequently occurring option, weekly pay periods can be somewhat expensive to administer. Monthly pay periods aren't typically embraced by companies because of strict state regulations and a lack of interest among employees. Most companies choose either bi-weekly or semi-monthly pay periods, so let's focus on these two options.

2. Bi-weekly payroll. With bi-weekly payroll, employees are paid every other week on the same day. Since there are 52 weeks in a year, this means they receive 26 pay checks. Dividing 26 paychecks into 12 months doesn’t work evenly so companies add an additional paycheck twice during the year, most often in January and July. 

3. Semi-monthly payroll. With semi-monthly payroll, employees are paid twice per month on the same calendar dates. It's most common for companies to choose the 15th of the month and the last day of the month as the two cutoffs to mark the end of each payroll period. Because those dates could fall on any given day of the week, adjustments need to be made. For example, the first semi-monthly payroll for February 2015 would be due on Feb. 15, which falls on a Sunday. In cases like this, payments are usually made on the most recent previous weekday.

Additional Issues to Consider

There are other factors that must be considered when choosing between bi-weekly and semi-monthly pay periods. The Fair Labor Standards Act (FLSA) regulates many areas of employment. It requires that all nonexempt employees (usually the ones that are paid by the hour) receive, at the very least, the Federal minimum wage for the first 40 hours of work per work week. After that, any additional hours worked for that work week must be paid at 1.5 times the hourly rate. The U.S. Department of Labor (DOL) defines a work week as a “fixed and regularly recurring period of 168 hours.” It can start at any time on any day of the week, but once it starts, it keeps going until 168 hours have been reached.

With a bi-weekly pay period, identifying a work week and calculating overtime is relatively easy. The period always ends on the same day of the week, and the periods are always the same number of days.

This isn’t the case with a semi-monthly pay period, however, which can end on different days of the week and can consist of a different number of days. With semi-monthly pay periods, both pay periods and work week periods don’t always overlap perfectly. This complicates overtime pay calculations, which can lead to confusion among workers while increasing the risk of mistakes that could lead to disciplinary action by the DOL.

In addition to federal regulations, most state governments require a minimum payment frequency for companies hiring people within their state. This requirement is more stringent than that of the FLSA's. While the FLSA permits monthly pay periods, most states don't. Some states also have different minimum pay period requirements depending on the nature of the job and the industry. The DOL maintains a table of state payday requirements for easy reference.

One more thing to consider: Many payroll processing services charge clients a fee each time they process a payment. The less frequent the payments, the lower your overall payroll processing costs will be.

Accounting Practices

For practically all companies, a month is the standard unit of time used to record revenues and expenses and measure performance. From an accounting perspective, it’s much simpler to organize everything in terms of months. For that reason, the semi-monthly pay period is easier to manage since there are exactly two per month.

With the 26 bi-weekly periods, some labor costs will have to be accrued during the period the work was done but paid during the following period. This is more cumbersome for accounting especially when preparing performance reports and trying to compare costs from month to month.

This difference also exists when dealing with employee benefits. Deductions for benefits are done on a monthly basis, making them ideal for a semi-monthly payroll, while bi-weekly payroll adjustments need to be made throughout the year.

The Best Option

Selecting the best option for your small business depends on ... well, your small business. Companies with many hourly workers would be best served with a bi-weekly payroll—handling overtime pay is simpler, and employees like the predictability of knowing that their pay will arrive on the same day of the week. Many workers also like the extra two payments per year that coincide with the two additional pay periods.

Companies without hourly workers could use the semi-monthly structure to keep their accounting simpler. Exempt employees (those earning a fixed salary) wouldn’t see much benefit from one system versus the other since they don’t qualify for overtime.

Another option would be to split the difference; keep hourly works on a bi-weekly payroll schedule and salaried employees on a semi-monthly schedule. Many larger companies do this, and for some small businesses, it could be the best of both worlds.

Read more articles on small-business finance

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