Payroll is the process of paying your employees. It includes working out how much they should be paid, taking off tax and National Insurance, and making sure they receive the right amount on time.
Payroll can seem confusing, especially if you are new to running a business. There are different rules to follow and several things to keep track of each time you pay your staff.
In this guide, we’ll explain payroll in simple terms. We’ll look at what payroll means, what it includes, how it works and what you need to do as an employer. Whether you run a small business or are just learning about payroll, this guide will help you understand the basics.
Key Facts
- What is payroll? Payroll is the process of calculating and distributing employee earnings, deducting income tax and National Insurance via PAYE, and reporting those deductions to HMRC in real time through RTI submissions.
- Cost of errors: PwC UK research found that the average FTSE 100 company loses between £10 million and £30 million per year to payroll errors – a risk that scales down to SMEs through fines, back-pay orders, and staff turnover.
- Minimum wage compliance: From 1 April 2026, the National Living Wage rose to £12.71 per hour for workers aged 21 and over – a 4.1% increase affecting around 2.7 million workers across the UK, according to GOV.UK.
In this article, we’ll examine the elements of this essential business function and take a look at what it takes to run an effective payroll process. We’ll be covering the following:
Table of Contents
- What is payroll in the UK?
- What are the key elements of payroll?
- How do companies run payroll in the UK?
- Who is responsible for managing payroll in the UK?
- How to improve payroll management in 2026
- Payroll with Factorial
- UK payroll compliance: what every employer needs to know in 2026
What is payroll in the UK?
The term ‘payroll’ originally referred to a list of employees and the amounts owed to them. Today, the definition is far more nuanced: in the UK, payroll encompasses the PAYE (Pay As You Earn) system through which employers deduct income tax and National Insurance contributions (NICs) before paying staff, then report those deductions to HMRC via Real Time Information (RTI) submissions on or before each payday.
The basic concept of payroll is calculating and distributing employee earnings, but such a simple description doesn’t encompass the various forms of compensation, deductions, and tax obligations that payroll departments have to factor in to ensure they get it right.
Payroll records must be kept for a minimum of three years from the end of the tax year they relate to – a legal requirement under HMRC rules that applies to all UK employers regardless of size.
What are the key elements of payroll?
Payroll is a critical component of every organisation and encompasses essential elements that ensure employees are compensated accurately and on time while maintaining compliance with tax and employment law. This, in turn, helps create a positive work environment and ensures your business remains on the right side of employment law.
- Employee Compensation – Central to payroll is calculating and distributing employees’ gross pay. This includes various forms of compensation, such as hourly employee wages, salaries, commissions, and performance-based bonuses.
- Deductions – It also involves managing deductions, including compulsory deductions, such as income tax, and voluntary deductions, such as company benefits.
- Tax Deductions – Employers must deduct income tax and National Insurance contributions (NICs) through PAYE and submit a Full Payment Submission (FPS) to HMRC on or before each payday. For the 2026/27 tax year, the personal allowance stands at £12,570, with the basic income tax rate of 20% applying to earnings above that threshold. Employer NICs are charged at 15% on earnings above the secondary threshold of £5,000 per year.
- Benefits Administration – Payroll also plays a role in the administration of employee benefits and pre-tax deductions, including health insurance, pension contributions, paid time off, and other perks the employer offers, like salary sacrifice schemes.
- Pension Auto-Enrolment – Under the Pensions Act 2008, UK employers must automatically enrol eligible employees into a qualifying workplace pension scheme. Eligible workers are those aged between 22 and state pension age who earn more than £10,000 per year. Employers must also make a minimum contribution of 3% of qualifying earnings.
- Record Keeping – Accurate record-keeping is a critical part of payroll. For transparency and compliance, employers must maintain detailed records of payroll transactions, money paid, earnings, deductions, and tax-related data.
- Payroll Software and Technology – Many organisations use payroll software and services to automate and improve payroll functions. These solutions require effective management by the team responsible but help increase efficiency and reduce errors.
How do companies run payroll in the UK?
Running payroll in a company is a global process involving several key steps:
- Collect Employee Information – Gather details about each employee, including their work hours, earnings, tax information, and any deductions or benefits.
- Calculate Earnings – Determine the total amount each employee has earned, considering regular pay, overtime, bonuses, and other forms of compensation.
- Deduct Taxes and Contributions – Subtract the necessary payroll taxes, like income tax, National Insurance, and pension contributions, as well as employee benefits like health insurance and authorised deductions, such as check-off payments to unions.
- Comply with Regulations – Stay on top of tax laws, minimum wage requirements, and other employment regulations to keep the business compliant.
- Generate Payments – Paying your workforce accurately and on time is the core output of every payroll cycle. Bacs (Bankers’ Automated Clearing Service) is the dominant payment method in the UK, with the vast majority of employees receiving wages via direct bank transfer. However, cash, cheques, and other electronic payment methods remain in use. Employers must also pay any PAYE and NIC liabilities to HMRC by the 22nd of the following tax month when paying electronically.
- Provide Pay Statements – Employers are required by law to give their employees detailed pay statements that show their earnings, deductions, and net pay.
- Handle Tax Filings – Not only must employers pay tax, but they also need to submit the necessary tax forms and reports to government agencies as required.
- Maintain Records – Keep comprehensive records of payroll transactions, tax filings, and employee information.
- Register as an Employer with HMRC – Before running payroll for the first time, UK employers must register with HMRC as a PAYE employer. Registration must be completed before the first payday, and HMRC can take up to 15 working days to issue the Employer PAYE reference number needed to submit RTI reports.
Who is responsible for managing payroll in the UK?
The responsibility for managing and processing payroll will differ slightly from company to company. In most cases, payroll will usually sit with the organisation’s human resources department or a dedicated payroll department.
Larger organisations are more likely to have a dedicated payroll department, whereas in smaller companies, HR personnel may handle both HR and payroll responsibilities. Regardless of the structure to manage payroll, however, collaboration between HR and payroll is essential to ensure employees are paid accurately and on time while remaining compliant with relevant laws and regulations.
In the UK, payroll compliance is ultimately the employer’s legal responsibility, regardless of whether the function is handled in-house or outsourced to a third-party payroll bureau. The Employment Rights Act 2025 – the most significant reform of UK employment law in a generation – introduced new obligations that directly affect payroll teams, including day-one Statutory Sick Pay (removing the previous three-day waiting period) and day-one paternity leave rights, according to the Chartered Institute of Personnel and Development.
Who Is Involved in Payroll?
Payroll often involves more than just working out how much employees should be paid. Different people may have a role in making sure payroll is accurate and runs smoothly.
HR Team
The HR team usually looks after employee information and provides the details needed for payroll. This can include:
- Employee details: Keeping information such as names, addresses, bank details and tax information up to date.
- Working hours and leave: Recording working hours, overtime, sick leave and annual leave where needed.
- Employee benefits: Managing workplace benefits, such as pensions and other employee benefits.
- Tax information: Providing payroll with the correct information, such as an employee’s tax code and starter details.
- Following employment rules: Making sure employee records and processes follow UK employment laws and requirements.
Payroll Team
The payroll team uses this information to work out and process employee pay. Their responsibilities can include:
- Calculating pay: Working out gross pay, tax, National Insurance and other deductions.
- Processing payments: Making sure employees are paid the correct amount and on time.
- Reporting to HMRC: Sending the required payroll information to HM Revenue & Customs (HMRC).
- Keeping records: Keeping accurate records of employee pay, deductions and payroll transactions.
- Handling changes: Updating payroll when an employee’s pay, tax code, working hours or other details change.
In smaller businesses, one person may handle both HR and payroll tasks. Some businesses also use a payroll provider or payroll software to help manage the process.
When should you outsource payroll?
Many UK businesses – particularly SMEs – choose to outsource payroll to a specialist bureau or accountant rather than manage it in-house. Outsourcing can reduce the risk of HMRC penalties, which range from £100 to £400 per month for late RTI submissions depending on the number of employees in the PAYE scheme. It also transfers the burden of keeping up with annual legislative changes, such as updated National Living Wage rates and new statutory payment rules, to a specialist provider.
The decision typically comes down to headcount, internal expertise, and the complexity of your pay structure. Businesses with straightforward monthly payroll and a small workforce may manage adequately in-house with compliant software. Those with variable hours, multiple pay frequencies, or complex benefits arrangements often benefit from professional support.
How to improve payroll management in 2026
Managing payroll accurately and efficiently is important for every business. The right processes and tools can help you save time, reduce errors and make sure your employees are paid correctly and on time.
If you’re looking to improve your payroll in 2026, here are some simple tips to help you get started:
- Integrate Systems: Connect your HR and accounting software into a unified payroll platform. A single source of truth for employee data reduces the manual re-keying that causes most RTI submission errors and ensures your PAYE calculations stay consistent across every pay run.
- Build Trust: Open communication builds trust. When it comes to payroll, this means being transparent with employees by providing clear and accessible information about their earnings and deductions.
- Stay Compliant: Monitor HMRC guidance and legislative updates throughout the year. The 2026/27 tax year brought significant changes – including a rise in the National Living Wage to £12.71 per hour for workers aged 21 and over and an increase in employer NICs to 15% – and further reforms under the Employment Rights Act 2025 are scheduled for implementation in 2027.
- Accessibility Matters: Improve employee access to their payroll information through user-friendly portals or apps. This makes it easy for them to check their pay.
- Employee Engagement: Once your employees are engaged with the process, get feedback to understand their payroll needs and concerns. This will help you adapt your payroll practices to their preferences.
- Check, Check and Recheck: Keep your audits consistent and regular so you can catch any errors and discrepancies before they become compliance issues.
- Use Automation: Automated payroll software reduces the manual tasks that cause most errors. PwC UK research found that the average FTSE 100 company loses between £10 million and £30 million per year to payroll mistakes – a figure that scales down to SMEs through HMRC penalties, back-pay orders, and staff turnover. Automation addresses the root causes of those losses.
- Choose the Right Software: Select payroll software that is recognised by HMRC and capable of submitting RTI reports directly. Factorial’s payroll platform, for example, automates FPS submissions, calculates PAYE and NIC deductions, and integrates with your existing finance tools. This reduces the manual workload that leads to costly errors.
- Knowledge Is Power: Train your staff properly on any new software to maximise its potential.
Payroll with Factorial
Factorial’s payroll software simplifies and centralises processes to ensure total control, ease of use, real-time data, and, most importantly, an error-free payday.
Here are some of the things our automated payroll management and accounting software can help you with:
- Efficient Payroll Centralisation: Our software combines all your payroll processes into a single platform, making it easy to approve expenses and automatically reimburse them through payroll. You can view these expense requests on your mobile or desktop and categorise them for a more comprehensive spending analysis.
- Automated Task Handling: By automating payroll, you reduce the chances of errors and ensure precise payments. Factorial’s platform automates various tasks, including communication, fixed supplements, and calculations, and integrates with your existing providers thanks to an open API.
- Customised Workflow Efficiency: Adapt Factorial’s payslip software to your preferences by setting payment cycle lengths, choosing compensation settings, and categorising compensation. You can also communicate with your finance department by integrating Factorial’s software into your existing workflows and involving your bookkeeper at every step.
- Informed Decision-Making with Data Insights: Our software provides valuable insights into company costs, salary trends, and employer-paid benefits, enabling you to make well-informed decisions and manage your finances effectively.
Our Automated Payroll Management Software is part of a complete HR software package. Manage time, holidays, your payroll records, performance, and more, all from one place, with Factorial.
Join the 16,000+ companies worldwide that trust us and discover why we’ve earned a spot in G2’s Top 50 HR Products. Choose Factorial because you have better things to do than manual HR work!
UK payroll compliance: what every employer needs to know in 2026
Running payroll in the UK means operating within a tightly regulated framework. HMRC’s PAYE system requires employers to deduct income tax and National Insurance from every employee’s pay and report those deductions through a Full Payment Submission (FPS) on or before each payday. Failure to submit on time can trigger automatic penalties ranging from £100 to £400 per month, depending on the size of your PAYE scheme.
The 2026/27 tax year brought the most significant structural changes to UK payroll in years. From 1 April 2026, the National Living Wage rose to £12.71 per hour for workers aged 21 and over – a 4.1% increase that affected approximately 2.7 million workers across the UK, according to GOV.UK. Employer NICs also increased to 15% on earnings above the secondary threshold of £5,000 per year, raising the cost of employment for every business with staff on the payroll.
The Employment Rights Act 2025 added further obligations. Day-one Statutory Sick Pay – removing the previous three-day waiting period – and day-one paternity leave rights are now in force, and the newly established Fair Work Agency has the power to issue penalties of up to 200% of underpaid wages for minimum wage breaches, according to the Chartered Institute of Personnel and Development.
Keeping pace with these changes is not optional. Buying up-to-date payroll software and staying informed about HMRC guidance are the two most effective ways to manage that obligation without it becoming a liability.
FAQ
How does payroll work?
Payroll is the process of calculating and distributing employee earnings. It involves gathering employee data, calculating gross pay, withholding taxes and other deductions, and issuing net pay. The process also includes filing taxes with government agencies and maintaining detailed records for compliance.
What is the simple definition of payroll?
Payroll is the complete process of paying a company’s employees. It encompasses calculating earnings, withholding taxes and other deductions like pension contributions, and distributing the final net pay to employees on a consistent schedule.
What are the four types of payroll?
Payroll can be categorized by how employees are compensated. The four common types are salaried (a fixed annual amount), hourly (paid for hours worked), commission-based (tied to performance or sales), and bonus payments (for specific achievements).
How to do payroll for beginners?
For beginners, the key steps are gathering employee data, calculating gross pay, withholding taxes and other deductions, and issuing payment. To simplify this and ensure compliance, using an all-in-one business management software like Factorial can automate calculations and simplify the entire process.
