The high-cost of payroll leakage (and what to do about it)

One of the great moments in a growing business is taking on the first outside employee. It’s an exciting, nerve-wracking step that gives the founders of the business a real sense of progress. The payroll process for this first employee is relatively straightforward and is often just another task the founder must take on themselves.

As the business grows even further, however, payroll becomes its own beast, fraught with challenges, risks, and potential hidden costs. From a source of excitement, payroll soon becomes a source of risk.

The total costs of payroll to a business typically lies somewhere between the 15-30% of gross revenue range, with labor-intensives businesses reaching up to 50% in some cases, so getting a controlled, efficient payroll process is one of the most fundamental tasks of any management team.

‘Payroll leakage’ is one of those catch-all terms that encompasses all those things that can go wrong in the payroll process and cause additional administrative burden or cost to the business. With payroll being such a high percentage of gross revenue, these errors can be extremely costly, and even devastating for a growing business.

Typical types of payroll leakage in a business

Types of payroll leakage range from errors in basic data collection and entry, the processes followed, and technology used. Some are common across all businesses, while others really only come into play when an organization reaches a certain scale.

Errors in data collection

The first type of payroll leakage through bad data is a classic – wrong data entry on timesheets and expense reports. Whether deliberate or not, employees entering wrong hours or expenses will cost your business; not just in additional payroll, but also in terms of being able to accurately estimate future costs and time spent on similar projects.

Every timesheet system is open to this type of fraud, but there are basic actions you can take to prevent it, or at least limit it.

Informing your employees about timesheet policies and penalties is your first step, while having managers regularly check timesheets is a good way of catching problems early. And you should tackle these problems as early as possible – big frauds start with small steps. You can also use automated timesheet software which will prevent retroactive editing of timesheets and provide other security measures.

In reality though, accurate timesheet entry is all about the culture in your business. Micromanaging timesheets or overtly ‘Big Brother’ policies will probably do more damage than good. By acting sensibly, treating your employees like adults, and having regular spot-checks, this type of payroll leakage will never get out of hand.

Studies show an error rate of between 1-8% of total payroll in companies that use traditional timecards. - The American Payroll Association

Using outmoded processes and systems

If you’re managing your payroll on an Excel sheet, it’s probably best to walk away from your computer and think carefully before you add another column. There are two fundamental problems with using Excel for payroll – human error in data entry (both in numbers inputted and formulas used) and inability to accurately check back on errors.

Of course, the size of the risk directly correlates with the size of your business. If you have a couple of people on the payroll, Excel might be perfectly capable of fulfilling your needs – it’s when you grow beyond a certain headcount that any errors can compound themselves and turn into a real mess.

Using automated software or partnering with global payroll providers will eliminate these risks and allow your payroll to scale with your business.

Just two payroll errors can cause 49% of employees to start job hunting - The Workforce Institute at Kronos

Local compliance rules and taxes

Just as taxes are a certainty in life, so are changes in tax law. Often, this is essentially a non-problem as the changes in tax law will be updated automatically and reflected in an employee paycheck.

However, in the modern era of hybrid working when employees may move jurisdictions, it’s becoming more of an issue for employers themselves. Keeping track of where your employees are based, especially in a large enterprise, and ensuring their payroll details are up to date, will become a more regular job for payroll departments.  

This is in addition to activities payroll need to keep on top of anyway. For example, in the US, payroll departments need to consider the Federal Insurance Contributions Act (FICA) which requires US businesses to withhold three separate tax from their employees’ wages – social security, Medicare, and the Medicare surtax. Most countries will have similar types of law. 

Beyond taxes, local regulations must also be adhered to. This can be fundamental laws such as a minimum wage, paid sick leave rules, and pay equity legislation, and will also include nuances such as part-time employee vs full-time employee legislation.

There are two basic solutions here; 1) Keep track of everything yourself or 2) Outsource your payroll to an external vendor who will keep track of things for you.

FX payroll leakage

A significant challenge for those businesses with international payroll is leakage through FX (foreign exchange). When paying in one currency into another, businesses will be hit through commissions, currency fluctuations and additional administration work when FX issues cause payment errors.

In practical terms, using traditional banking payment rails means that a payroll payment sent through the chain may not end up being the payment received by the employee. Depending on who handled the money (and you may not always have visibility on this before sending) the FX commission taken and the currency fluctuations that happened during the process, may result in having to send additional payments to make up the shortfall.

These are costs businesses have been swallowing for years, but now there is an alternative.

Modern payment rails, combined with platforms built by fintech’s, mean that businesses can significantly reduce both FX costs, and exposure to its risks. They allow payments to go through less handlers, lock-in FX rates at the time of payment and give full visibility to the user as the money flows through the chain.

Saving a couple of percentage points on each payment, adding cumulatively over time, can result in genuinely significant bottom-line savings.

It's estimated that around one-third of employers make a payroll mistake in any given year. - INTERNAL REVENUE SERVICE (IRS)

Big payroll expenses equal big opportunities for savings

The exciting days in business involve chasing those shiny new objects – a big client, a new product launch, a new revenue source – but the most productive days can often be based on fixing fundamentals.

With payroll being such a regular, big expense, getting your payroll processes and systems right will result in unlocking capital that can be used elsewhere in the business. It’s an archetypal ‘look after the cents, and the dollars will look after themselves’ issue. In most cases, payroll leakage will have a multiplier effect, compounding itself each pay day and leaving little room for recourse once an error is spotted.

By finding these mistakes early, or preventing them entirely, hiring your thousandth employee will be just as exciting and easy to manage as your first.

To learn how TransferMate can reduce payroll leakage in your organization and provide significant bottom-line savings, click here.