So far in our four-part series on outsourcing finance functions, we have discussed cash inflows and cash outflows for customers and suppliers. These are handled by the accounts payable (AP) and accounts receivable (AR) departments. In this article, we will explore another cash outflow function: payroll. For very large companies, payroll might be its own department entirely. In smaller firms, it might fall under the umbrella of HR and finance. In very small firms, it might just be “the guy who pays everyone,” which could even be the founder.
As a company grows, it will need to develop an efficient workflow and methodology for payroll, just as it must for AP and AR. For the firms that are poised for the growth stage or already experiencing it, outsourcing payroll may be worthwhile.
The role of payroll
What does payroll do? An obvious and primary function is to ensure employees receive their pay on time, in the correct amount, and with any deductions or additions already incorporated. The payroll department makes those adjustments every period, as well as performing reconciliation and audits over time.
An equally important role is to ensure government entities also receive their tax revenue in the correct amount, on time, and in compliance with ever-changing tax laws. In general, payroll taxes paid by companies cannot simply be calculated and sent at the end of the year— they must be regularly deposited with the appropriate authority. A functioning payroll department ensures this essential action occurs smoothly and complies with the current requirements.
Beyond the shifting federal requirements, each state maintains its own set of tax laws, significantly complicating the filing process for any interstate business. The employment of remote personnel who fall under another state’s jurisdiction would require knowledge of the resident state’s taxes, and payroll ensures these laws are monitored and appropriately followed. Maintaining accurate employment records and updating them accordingly is also an important, government-mandated duty of payroll.
Why maintain a payroll department?
One of the most convincing arguments for maintaining dedicated payroll personnel is to avoid government challenges. Major changes to law, like the highly publicized Tax Cuts and Jobs Act of 2017, will have complex and extensive consequences best interpreted by professionals. Many smaller tax changes are enacted every year, and staying on top of these is essential, as ignorance is rarely a defense in tax litigation. Even the seemingly simple activity of tax deposits could be complicated if payments are made biweekly, since the deposit schedule is based on the day of the week, and biweekly paychecks mean the day of the week probably changes every pay period.
Companies with many employees or with variable-hour employees must maintain more records, update them more frequently, and pay close attention to their obligations. Moreover, contractors, one-time tasks, and other non-recurring employment schemes demand their own set of filings, like the 1099 supplied to contractors. Without dedicated payroll personnel, some of these requirements may be overlooked, resulting in consequences from unhappy governments or unhappy employees (who might be missing bonuses or some pay adjustments). Removing these burdens from regular employees and employing dedicated payroll personnel will free the other members of the firm to focus on and perform their jobs more effectively.
Benefits of outsourcing the payroll function
Similar to the other functions we have looked at so far, outsourcing payroll provides several benefits to the outsourcing firm, particularly regarding expertise, technology, and security.
When a firm outsources, it gains invaluable expertise immediately, without the need to employ a full-time professional. For payroll, this expertise covers knowledge of accounting and payroll systems in addition to the legal landscape. The legal aspect of the contracted professional’s knowledge is vital: payroll software, while possibly complex, can be learned by internal personnel fairly quickly; the preexisting knowledge of the broad and complex legal landscape is not something easily learned, not to mention the skills needed to quickly assimilate information regarding new laws and how they will affect the company.
Often outsourced professionals will also offer some insights into pay structure from other companies that may be worthwhile to implement at the contracting company, such as balancing vacation time and bonuses. The individual might be able to advise finance, HR, and management on how to best monetarily motivate employees without breaking the bank. By bringing in full expertise on a part-time basis, the growing company doubly benefits.
One reason many firms shy away from outsourcing payroll is to protect their wage and HR data. For those concerned with security when dealing with external personnel, maintaining a browser-based portal with no download capabilities significantly reduces the chances of data leakage. Outsourcing also makes partial knowledge easier to implement, where two or more contracted individuals are less likely to collude (as they are unlikely to have contact with each other), and any two contractors can be denied access to the entire dataset, reducing risk.
Thus a byproduct of using external professionals is the lack of extensive access to various systems. Since the payroll function tends to straddle the finance and HR departments, an internal employee acting as payroll will be privy to significant amounts of sensitive information. An external party’s access can be limited more easily, especially if the individual is rarely physically present at the company’s offices. This leads to tighter controls on individual data access, and ultimately more security for the firm.
One caveat – Straight from the IRS
The IRS warns that companies are ultimately responsible for depositing taxes and record keeping. So when outsourcing payroll, the company should perform its due diligence and preferably implement policies for auditing and ensuring tax deposits and records are properly maintained. Contracted individuals will very likely be benevolent, but companies should always protect themselves regardless.
Failure to pay taxes as required will bring hefty consequences, and it will not be possible to shift liability to the outsourced individual. For that reason, CFOs and other internal finance officers should have at least a basic grasp on how much the company should be paying in taxes and the associated filings. The actual number crunching can be left up to the contractor, but a ballpark estimate will go a long way in ensuring the company does not run afoul of the IRS.
Should you outsource your payroll function?
A small firm with stably salaried employees may be better off simply performing payroll in-house. The records will change infrequently, tax deposits will be similar every period, and there are unlikely to be disruptive adjustments to paychecks every period. Growing firms, however, would be wise to consider building their payroll functions before it is too late. The payroll function is not simply a “pay the employees” function but also operates under a wide-ranging set of laws that quickly become complicated as the business grows. Laying the foundation for a strong payroll department is essential early in the growth cycle.
Just like for the other finance functions, outsourcing is an excellent way to reap the benefits of experience, expertise, and technological access while still controlling costs.