How to Calculate Payroll: A Complete Step-by-Step Guide

For any business, having a streamlined payroll system is important. If you are an organization with many employees, accurate and swift payroll calculation is next to impossible which is why, as a responsible organization, your first order of business must be to automate your payroll process. Payroll delays and errors do not just create chaos among employees but can affect your organisation’s credibility as well.

When it comes to processing payroll the first most critical step is calculate the payroll right. There are techniques that can be used to ensure accuracy when it comes to calculating your payroll.

What is Payroll Calculating?

Payroll calculation is the process of calculating the amount of money an organization pays its employees for the work they deliver during a specific period. This includes their salaries, bonuses, and other benefits after withholding the required taxes from their gross pay.

Calculating payroll can be a complex procedure, as there are several factors that impact the calculation.

Some of the crucial factors that affect the payroll calculation in India are-

1. Income tax

Employees working with a legit employer are subject to income tax based on their salary and allowances. Employers are required to deduct the necessary taxes from the employee’s gross pay before disbursement.

2. EPF (Employee Provident fund)

All employees are liable to contribute to the employee’s provident fund, a retirement benefits scheme. The contribution is usually 12% of the employee’s salary.

3. ESI (Employee State Insurance)

The ESI is a social security scheme that provides employees with medical and cash benefits. Every employer with an organization strength of more than 10 employees must register under the ESI Act. Employers contribute 4.75% of the employee’s salary(gross pay) and employees contribute 1.75% of their salary.

4. PT (Professional Tax)

This varies from state to state. Some states in India levy a professional tax on employees, a minimum amount, which is deducted from their salaries.

5. Encashment of Paid leaves

A certain number of leaves are provided to employees annually, like privilege leaves, sick leaves, and casual leaves. In case an employee does not uses all their leaves, they are entitled to encash them at the end of the year. The amount depends on the employee’s salary and number of leave days.

How to Calculate Payroll Taxes: Basics

There are certain basic rules to be followed while calculating payroll taxes. Note that we are explicitly talking about the calculation of only payroll taxes and not the entire calculation of payroll.

There are two regimes according to which payroll taxes can be calculated and employees can choose either one of them.

1. Old tax regime

• Income Tax formula for old tax regime = (Basic + Allowances – Deductions) * 12 – (IT Declarations + Standard deduction)
• Deductions are the sum of ESI and PT etc.
• Standard deduction (50,000)

2. New tax regime

• Income Tax formula for new tax regime= (Basic + Allowances – Deductions (ESI)) * 12 – (Standard deduction)
• Only ESI is considered as a deduction.
• Standard Deduction (50,000)

Taxpayers can opt either regime to pay taxes by carefully considering the exemptions and other leniencies allowed and the difference between the two.

Payroll Calculations

Payroll Calculations constitute of 4 main components:

• Basic Pay
• Allowances
• Deductions
• IT declarations

To calculate each of these components there are specific formulas that must be followed. A payroll calculator can streamline the process of payroll calculations for each employee’s earnings, taxes, and net pay.

Payroll Calculation Formulas

Net pay is the final payout that is disbursed to an employee after all the necessary deductions made.

Net Pay= Gross Pay- Gross deduction

Gross pay = Basic salary + HRA + DA + Allowances + One-time payment/incentive (Reimbursements, Arrears, Bonus, etc.)

Gross Deduction = Professional Tax + Employees’ State Insurance + Public Provident Fund + Income Tax + Insurance + Leave adjustments + One-time deduction (Loan recovery)

• Basic salary= 50% of Gross pay (Gross*0.5)
• HRA (House Rent allowance) = an amount received from the employer as part of allowances.

The amount of HRA you are allowed= Actual rent paid less 10% of the basic salary

If you are staying a metropolitan city, 50% of the basic salary is allocated, and if staying in a non-metro city, 40% of the basic salary is allocated.

• Professional Tax= 12% of Basic pay + PF allowance if applicable
• Employee State Insurance= 0.75% of Gross pay
• Income tax calculation depends on the type of regime

Net pay is the in-hand salary an employee receives at the end of the pay period. The net pay calculation depends on the CTC structure.

Processing of Payroll

Once you have calculated the net pay, you can go ahead and process the employees’ salaries through the specified method of payment on the specified date as per the pay policy. Make sure that there are no delays in processing payroll. It helps in running the company efficiently as well as gain the employee’s trust.

Make sure to upload the payslips on the ESS portal for your employees’ reference post processing their salaries. It helps them get loans, get future employment as it acts as a legal document of employment.

Maintain Payroll Records

Post the calculation and disbursement of salaries it’s important to maintain payroll records. Some of the reasons for maintaining these records are-

• Avoidance of compliance issues in the future.
• In case of salary deductions, there must be a record of the same to avoid salary disputes in the future.
• According to payroll laws, all organizations must maintain payroll records periodically.

What are the Options of Calculating and Recording Payroll?

There are numerous ways of calculating and recording payroll. Depending on the size and complexity of your organization, you can choose your preferred option of processing payroll.

There are three main options:

1. Manually

Manual calculation of payroll using paper-based math isn’t much preferable in this advanced era of technology. Also, because this method requires extensive human intervention, is time consuming and more prone to errors.

If you are a small company with a less strength and are comfortable processing payroll manually then you can. But its best to have a person who understands the in and out of processing payroll regardless of the method you choose.

2. Excel sheets

Excel sheets are one level up in terms of ease than manual payroll processing. But again, there is a risk of data theft in this method. However, excel sheets can help you distribute the hours, minutes, and other conversions efficiently and quickly into the sheets.

Make sure you update the sheets after every payroll as well as double check it.

3. Cloud-based Software

This is the most effective solution for calculating and processing payroll. A payroll software helps streamline your payroll process by calculating and converting the rates without the need for human intervention. The salary system can be pre-integrated with time and leave management solutions facilitating easy gathering of all the data required.

Make sure you choose the right payroll software which has a reasonable price in order to avoid mismanagement.

Are You Looking for Payroll Solutions?

Payroll Calculations can be tedious and time consuming. Whether you are a small, mid-sized or a large business, processing payroll right is an extremely important part of the organization. Having a dedicated payroll team is essential to ensure smooth processing of payroll. This is where we come in.

Alp Consulting has been a leading payroll solutions provider for decades now. Our experience and expertise at calculating, processing, and managing payroll, helps our clients run their business efficiently, while we take care of one of the complex functions of their organization. Our comprehensive payroll services are made for organizations of all sizes and caters to all industries.

If you are an organization looking for the right payroll solution for your business, reach out to us today and we’ll help you with your payroll challenges by streamlining your payroll process.