What Percentage of Operating Expenses Should Be Payroll?

Human resources are one of the most crucial assets for most companies. Although some companies have reduced the need to rely on them, these resources are still vital to survival. Usually, it includes the employees that work for a company. Although companies cannot recognize these employees as an asset in accounting, they provide significant value.

Companies hire employees through various processes. These processes differ based on several factors. Usually, a company’s HR department is responsible for conducting and overlooking it. Once companies employ workers, they must also bear other expenses for them. These expenses differ from one company to another and fall under payroll. Preparing and maintaining payroll also falls under the duties of the HR department.

Payroll is one of the most significant expenses for some companies. These companies rely on their labour for their production and other processes. Nonetheless, companies must control payroll expenses in the long run. Some may wonder what percentage of operating expenses should payroll constitute. Before discussing that, it is crucial to understand both areas.

What is a Payroll Expense?

The term payroll constitutes the expenses paid toward employees for a specific period. In some cases, they also occur on a given date. Either way, payroll involves the compensation companies pay their employees in exchange for their work. All companies employ workers who contribute to various processes. After they finish their work, companies must pay them compensation in several forms.

A payroll expense represents a cost incurred by a company for employing workers. These include any compensations paid to the worker director. On top of that, it also consists of costs incurred indirectly but related to those workers. For example, companies may pay taxes on their employees’ behalf. Although this payment does not occur directly to them, it is still a part of payroll expenses.

For most companies, payroll is a separate function. As mentioned above, this function falls with the HR department. Some companies may also operate this function under the accounting department. Either way, it involves calculating the compensation companies must pay their employees. This payment occurs at regular intervals. However, those intervals may differ based on various factors.

Overall, payroll encompasses any expense incurred to employ workers. These expenses differ based on several factors. Companies maintain a payroll function that overlooks their payroll activities. Usually, payroll expenses come from compensation paid directly to an employee. In some cases, it consists of payments to third parties on the employee’s behalf. Together, they constitute the payroll expense for a company.

What are the Types of Payroll Expenses?

Payroll expenses combine various types of costs that a company bears for its employees. These costs may differ from one company to another. Usually, they are similar for companies operating within the same industry. Payroll expenses have various elements that they include when calculating the cost to the employer. They include the following.

Salaries, Wages, Bonuses and commissions

Salaries, wages, bonuses, and commissions constitute the compensation paid to employees directly. Usually, these payments occur through cash or other similar means. Companies calculate based on the work an employee performs. For the company, gross salaries and wages will be the payroll expense. However, the employee may not receive the same amount. Instead, they get the net amounts.

Withholding taxes

One of the primary reductions in gross salaries includes withholding taxes. These taxes differ based on the tax laws where a company operates. Usually, employers pay these taxes on an employee’s behalf. On top of that, they may also contribute to those taxes from their side. Together, they constitute a payroll expense that they must record. Companies pay these amounts to their relevant tax authority.

Contributions to insurance and saving plans

Companies may also contribute to insurance and saving plans on an employee’s behalf. These amounts constitute a deduction from gross salaries. In some cases, employees may choose not to participate in these plans. However, it may also be mandatory to do so sometimes. If a company contributes to these plans, it will constitute a payroll expense for it.

Employee benefits

The above types of payroll expenses concern compensation or payment to a part. In some cases, companies may also provide benefits to employees. Although it does not involve paying them directly, these benefits still constitute a payroll cost to the employer. Employee benefits may include paid holidays, health and dental benefits, retirement benefits, etc.

Is Payroll Expense an Operating Expense?

Companies pay salaries, wages, and other benefits to many employees. These employees may include those working on products and services directly. On top of that, it also involves payments to support staff who perform other activities. For example, they are responsible for administrative or selling operations. Either way, any compensation paid to these employees will fall under payroll expenses.

Some people may ask whether payroll is an operating expense. However, the answer to that is not as straightforward. Operating expenses in accounting include any costs incurred on operations. Usually, these include headings such as general, administrative, selling, and marketing expenses. Each of these functions requires employees who perform several tasks. Companies pay those employees compensation.

On top of that, companies also employ workers who work on their products or services. If these workers contribute to the process directly, they will fall under direct labor. In this case, the payroll expense is not an operating expense. Instead, it falls under the cost of sales. For most companies, any direct labor working on products or services will constitute a direct expense.

Any employees who don’t contribute to the process directly will not fall under the cost of sales. Instead, the payroll expense for those employees will become an operating expense. For companies, payroll can be a part of operating expenses or the cost of sales. The difference between both comes from the workers to whom they relate. For administrative and selling department employees, payroll is an operating expense.

What Percentage of Operating Expenses should be Payroll?

Payroll is an operating expense when paid to employees outside the cost of sales. For some companies, it will constitute a significant portion of operating expenses. However, it depends on how many workers a company employs. On top of that, the compensation paid to them will depend on various factors. Some companies calculate their payroll expense as a whole. When reporting them, they separate them into several headings.

There is no definitive answer to what percentage of operating expense should payroll be. The proportion will differ based on several factors. Usually, the industry in which a company operates dictates how much they pay toward operating staff salaries. In some industries, these may be significant. Either way, payroll can be a different percentage of operating expenses for companies.

Most companies prefer to keep their payroll expenses low. However, the industry where they operate will dictate how much it should be. Some companies may also go against that norm by increasing or decreasing their payroll expenses. Nonetheless, most companies still stay close to that amount. The lower these expenses are, the more profitable the company will be.

Usually, companies prefer payroll to be 10% to 20% of operating expenses. This percentage may be higher for companies in a labor-intensive industry. Sometimes, it can go up to 30%-40% of operating expenses. Some companies may also outsource several supporting functions. For these companies, payroll will be 5%-10% of operating expenses. However, their operating expenses will still reflect the outsourcing.

Conclusion

Payroll is a function in companies that handles employing workers. On top of that, it may also overlook the compensation paid to those employees. This compensation may come in various forms, as listed above. Payroll can be an operating expense or relate to the cost of sales. Usually, companies prefer it to be a small percentage of operating expenses.