For small businesses that want to build a team, payroll costs come with the territory. Beyond basic compensation, employers are responsible for payroll taxes, FICA (Social Security and Medicare), and FUTA (unemployment) taxes. At the same time, some businesses make additional investments in perks that attract talented new hires, such as 401(k) plans and employee healthcare benefits.
What you’ll learn
What you’ll learn
Updated: May 28, 2025
Key takeaways
- Payroll costs include both direct (wages, taxes, benefits) and indirect (software, processing) expenses
- Labor costs and payroll costs are different — tracking both supports better budgeting
- Cost per employee is a key metric for managing payroll efficiently as you grow
- Cutting indirect costs (like admin fees or pay frequency) can reduce expenses without hurting morale
Finding ways to reduce monthly payroll costs is often top of mind for small businesses operating with lean margins. In this article, we’ll break down what you need to know about payroll costs, what they commonly consist of, and some guidance on how to manage them.
Understanding payroll costs
Payroll costs fall into two categories:
- Direct costs are those that are directly tied to employee compensation, such as the actual compensation, employee benefits, taxes, and insurance.
- Indirect costs are indirectly associated with paying employees, such as payroll processing fees, payroll software costs, and the fees for outsourcing to professional services.
To learn more about what employers should keep in mind, we spoke with David Kindness, a certified public accountant with over a decade of experience helping small businesses and a frequent OnPay contributor.
What is the difference between labor cost and payroll cost?
“Labor costs include all expenses tied to paying and supporting employees, like wages, benefits, training, equipment, payroll fees, etc. Payroll costs, on the other hand, are a narrower category that covers just compensation, taxes, and deductions. Labor costs reflect your total investment in your workforce, while payroll costs focus specifically on salaries and wages. It’s important to keep track of both in order to budget accurately.”
— David Kindness. CPA
For example, a $50,000 salary plus $3,000 in benefits and $350 in equipment, training, and processing fees = $53,350 in labor cost, but only $50,000 in payroll cost. Small businesses often overlook indirect labor costs when considering labor costs and planning for headcount needs, which can skew results and potentially result in increased costs.
While the market largely dictates labor costs and the going rate to attract top talent, indirect payroll costs are much more within your control. If you’re doing payroll yourself, you can reduce your payroll costs.
Next, let’s find out more about what these costs consist of.
Key components of payroll costs
Your total payroll expenses are calculated by adding up all of the direct and indirect costs. This includes:
- Salaries and wages: Base pay, bonuses, commissions, overtime, and other compensation
- Taxes: The employer’s portion of payroll taxes, FICA taxes, and unemployment insurance (FUTA tax)
- Benefits: Employee benefits contributions, health insurance, retirement contributions, paid time off, and other leave
- Insurance: Workers’ compensation insurance
- Administrative fees: Payroll service provider fees, paycheck printing and delivery, and direct deposit fees
When you add all of these up for a pay period and divide by the number of employees you have, you’ll get your total cost per employee. This is a valuable metric to track over time.
Most of these numbers will increase as your business grows due to the higher labor costs necessary to run a larger business. However, indirect costs like administrative fees don’t necessarily have to grow at the same rate, which is why it’s important to calculate the specific administrative costs per employee rather than the actual cost to pay their salary. These costs are more within your control than just payroll costs, which are determined by the market. To learn more about other costs that can come up, once more we spoke with David.
What are other payroll fees examples?
“In addition to salaries and taxes, payroll includes several often-overlooked costs, such as processing charges (like direct deposit or check printing fees), payroll software subscriptions, and outsourcing costs if you use a third-party payroll provider. Businesses can also incur less obvious expenses, such as state unemployment insurance (SUI) tax rate adjustments, local payroll taxes (like city wage taxes), and workers’ compensation insurance premiums, which can fluctuate based on payroll size and industry risk.”
— David Kindness, CPA
David also says that there’s some costs that can fly under the radar. “Labor-related compliance costs can add up, including penalties for late tax filings, wage garnishment processing fees, and even bank fees for payroll account maintenance.”
Some businesses also have costs for time-tracking systems, PTO accrual management, or even HR support for payroll disputes. The takeaway is that its a good idea to keep track of it all. “These hidden expenses can significantly impact a small business’s bottom line, making it crucial to audit payroll reports regularly and negotiate with service providers when possible in order to minimize fees,” explains David.
Factors influencing payroll expenses
Several important elements influence payroll expenses. Understanding them will help you better control payroll expenses.
Some of the key factors are:
- Number of employees: The more employees you have, the higher your payroll costs will be. That’s why your cost per employee is an essential number to calculate so that you can focus specifically on the cost of payroll services rather than the cost of labor. You get a direct return from the productivity of labor, but indirect payroll costs don’t necessarily give the company the same benefit.
- Payroll frequency: Most payroll providers charge you every time you run payroll, so paying weekly will likely cost more than paying biweekly or monthly. Remember, though, most employees expect to get paid at least biweekly, so if you abruptly switch to monthly to reduce payroll costs, it may affect your team’s morale.
- Geographic location: Your payroll costs may rise due to state and local taxes, or you may have to pay more for labor due to a higher cost of living in your area.
Some of these components may be outside of your control. As your business grows, your payroll costs will grow alongside your operating expenses and revenues. That’s to be expected, as you need more employees to produce more goods, provide more services, and manage a larger business. But labor costs and payroll costs are not the same thing, so it’s important to optimize indirect payroll costs where you can, so you can continue to meet increasing labor costs as you hire the best talent in-house.
Ensuring compliance and satisfaction
Running payroll is one of a business’s most important responsibilities. Missing payroll directly impacts your employees’ lives, can lead to additional operating costs in other parts of the business, and might even expose the company to a lawsuit. Your contracts with employees are legally binding, and while many companies have been forgiven for missing one payroll cycle, it’s technically illegal to do so. Making a habit out of it will likely lead to significant legal consequences, fines, loss of reputation, or even potential jail time for business owners.
More importantly, however, poor payroll management can lead to unhappy employees, which can reduce productivity. One of the easiest ways to support employee retention and productivity is to make sure that employees are paid on time.
How to calculate payroll costs
You can use a payroll cost calculator to calculate the precise, itemized costs of payroll. That said, you don’t need a special tool; any calculator will work if you have the right numbers.
To calculate these costs, add all the direct and indirect costs for each employee. Then, divide by the number of employees to get an idea of the cost per employee. You can also target specific costs by getting the total sum and dividing it by the number of employees.
Once more, we caught up with David to get his take on what employers should be thinking about when developing their payroll budget.
How much should payroll cost?
“Payroll costs typically range between 15-30% of gross revenue for most small businesses, though this varies by industry. Labor-intensive sectors like restaurants or retail may see payroll costs as high as 35-50% of revenue, while professional service firms (accounting, law, architecture) often keep costs closer to 20-30%. But remember to factor in the following costs:
- Payroll taxes (FICA): 7.65% for FICA
- Payroll taxes (FUTA): 0.6% on the first $7k of each employee’s annual wages for unemployment taxes (for most states – some pay
- Benefits: health insurance, retirement matches, paid time off, dental, vision
- Administrative expenses: payroll software and processing fees
A good rule of thumb is to keep total labor costs (including payroll) below 50% of revenue to maintain healthy profitability.”
— David Kindness, CPA
However, the “right” payroll cost depends on your business model. For example, startups may temporarily run higher payroll costs to fuel growth, while seasonal businesses must budget for fluctuations. To optimize expenses, benchmark your payroll against industry standards regularly, automate payroll where possible, and audit for hidden fees or excess costs. Utilize payroll cost-per-employee metrics, and if costs exceed industry averages, then consider switching payroll providers or updating your processes.
Pros and cons of external payroll management
While you can run payroll yourself without using a payroll administrator, most businesses choose to work with a payroll services provider. Payroll is often complex, especially as you factor in variables like bonuses, commissions, tax filing, and employee time off. A payroll service provider streamlines every pay cycle with intuitive tools and handles your employer tax filing to help maximize your payroll deductions at the end of the year.
The major pro of handling payroll yourself is that you can reduce your payroll costs. However, this can put an enormous burden on your HR team, which — unless they have extensive experience working with payroll — will likely cost you more in lost efficiency. You may even risk a high employee turnover rate if HR staffers find the challenge of running payroll a lot to keep up with.
As such, even the most significant benefit of doing payroll yourself is largely offset by the burdens of running payroll for a growing team.
Bottom line: stay ahead of payroll costs to manage operations more efficiently
Understanding how much your business invests in payroll is a task that should show up on every employer’s to-do list. On one hand, it helps you plan ahead for hiring needs and keep tabs on the payroll taxes you’re responsible for. On the other hand, it enables you to budget effectively when deciding which employee perks you’re ready to start offering today and which you’ll have to plan for in the future.
With OnPay’s payroll software, you can seamlessly calculate variable payroll costs every cycle, schedule payroll to always run on time, and make sure that all state, federal, and local tax filings are accounted for. Growing your team may mean adding more payroll costs, but it also allows you to keep building your company and continue moving forward.
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.