Payroll is often viewed as unglamorous and unimportant, but tends to be one of the largest costs for any organisation. With increasingly complex and changing regulations to deal with, Bettina Pickering, Andy Edwards and John Harrison of PA Consulting Group consider the options for dealing with payroll as an end-to-end business process.

Although payroll is a major cost factor for organisations, it remains an area that is frequently excluded from improvement projects. Increasingly, however, payroll is becoming a focus area for a significant number of organisations. There are three key reasons for this:
1. HR or finance transformation programmes revive the age-old “turf war” between HR and finance as where payroll should sit within the organisation.
2. Payroll systems that have served the organisation well for years are becoming obsolete or are based on older programs that are no longer cost effective to run.
3. Long term payroll outsourcing contracts are coming to the end of their contract periods and organisations are seeking greater savings from this highly transactional function.
These factors present a good opportunity to review the payroll processes and systems for the value they deliver.

The HR v finance payroll turf war
Payroll does not naturally fit within either finance or HR because it combines characteristics of both areas. Payroll has a very administrative side, dealing with numbers and tax rules, which is culturally more in line with finance than HR. After all, finance has to transact the payment of the payroll and employment taxes, account for the transactions, check their integrity, and look out for corporate cost control.

On the other hand payroll deals with employees’ salaries and benefits, the legislative changes that may arise and any queries from employees about these issues. This element of the job is closer to HR than finance. Traditionally, HR managers see themselves as “owning” the relationship with the employee and pay is a key element in this relationship. HR will usually be responsible for remuneration policy, maintaining the organisation structure, and the transactions that “drive” payroll such as new starters, leavers, promotions and so on.

The result of this overlap is often conflict or tension between finance and HR. The department that does not deal with payroll usually feels it does not receive the service it requires, as payroll focuses more on the goals and objectives of the department it reports to. This situation can also lead to high profile errors such as:

• staff not being paid the right amount, due a delay in time data being delivered to the payroll
• Finance (if payroll reports to HR) not receiving the right headcount and/or payroll budget data on time or the required accuracy/level of detail
• HR (if payroll reports to finance) not being consulted on whether pay increases have been applied to the payroll correctly, or payroll processes being too rigid to allow joiner and leaver information being added to the payroll after the cut-off date.

There is no generic right answer where payroll should sit organisationally. But there is a right answer for each organisation. This answer depends on the entity's culture, strategy and organisational maturity. No matter where payroll is eventually located within the organisation, frequent communication and liaison is essential to eliminate conflict and inefficiences from teh relationship between finance and HR.

For example, an insurance organisation located payroll in its HR function, but appointed a qualified accountant as payroll manager. With this financial background, the payroll manager put various processes in place to guide the interaction between finance, HR and payroll.

One of the measures at this company included regular payroll review meetings involving all three parties to pinpoint process improvements and changing requirements. Assigning staff from finance and HR to meet and review payroll processing ensures that each department's requirements from payroll are met and the liaison team can play a key role when a new payroll system is considered – they will be able to ensure that all payroll requirements are taken into account rather than just one area’s requirements.

Choosing the right payroll system
Process requirements for payroll as a stand-alone function can be summed up as the secure and reliable processing of payroll data to facilitate the calculation, payment and recording of payroll liabilities.

Payroll has a potentially large number of touch points, depending on the nature, size and complexity of the organisation and its business processes. These factors drive the requirements for a payroll system and the degree of integration that is needed with other systems. The table (Table 1) below examines some of the more differentiated situations in terms of the additional integration requirements:

Typical payroll integration requirements by industry

Manufacturing/process industry

• Calculation of direct and indirect payroll standard costs by work areas and cost centres
• Maintenance of standard costs on item routings
• Capture of actual payroll activity against production orders
• Valuation of work in progress, including indirect labour and associated overhead
• Variance analysis on recoveries to support decision making, refinement of standards and performance measurement
• Integration with the pricing process

Service industry

• Collection and valuation of labour activity against customer contracts
• Integration with the billing system
• Integration with the pricing process
• Performance measurement, such as employee utilisation

Construction and contract engineering

• Calculation of direct and indirect payroll standard costs for complex and specific job costings
• Collection and valuation of labour activity against projects for valuation and cost control

All industries – Sales

• Integration with the sales organisation and billing systems for performance measurement and commission calculation

Public sector

• Capture of actual payroll activity against cost centre / department for review and control against funds based budget

As the payroll system has feeds from various business systems and also is the source of data for other business systems, any payroll system selection process must involve key staff from all areas which interact with payroll. This will ensure that no key payroll requirements and integration automation opportunities are missed.

One organisation, a manufacturing company, where the payroll function was located within the HR function, chose a new payroll system without consulting the finance and sales communities. The selection process for the new system was done on the assumption that a like for like system replacement with similar reports and data feeds would satisfy all parties. When the new system was being implemented, the organisation discovered that a significant cost saving could have been made, had the company implemented the payroll module (which had already been purchased) of the current finance system. It also discovered that the sales organisation was spending a significant amount of time calculating commission payments manually and re-formatting these figures to fit the current payroll upload formats. No provision had been made in the payroll selection process for an interface between the sales and the payroll systems – again a costly oversight for this particular organisation.

Outsourcing payroll
When choosing an outsourcer, the payroll feeder processes as well as the output processes need to be considered carefully to ensure best value for money. There is no point in getting cost of the outsourced payroll processes as low as possible when the integration points between the outsourced processes and the retained payroll processes or feeder/output processes are highly cost inefficient.

Payroll is perceived a highly administrative function and a commodity area, which can be outsourced easily. Therefore, numerous organisations have chosen to outsource it either fully or to some extent. Due to payroll’s peculiar profile within the organisation the management of the outsourcer and the strategic management of payroll is then often neglected since neither finance nor HR feels solely responsible. This leads to inefficiencies between various payroll feeder systems and the outsourced payroll, possibly causing delays, errors and adjustments.

Many of these “interfaces” into payroll still require manual intervention, for example keying time data, making sales staff commission adjustments or uploading payroll master and other transaction data manually. When outsourcing the payroll or re-letting a payroll service contract, these integration weaknesses need to be considered to ensure the overall solution remains cost-effective.

In a number of industries, payroll is one process the organisation cannot afford to get wrong. Organisations where a significant portion of the employee population is paid wages weekly/hourly – for example retail, transport, tourism and leisure – cannot afford to make payroll mistakes. If employees are paid late or incorrect amounts, they can often only prevented from a walk out through costly remedial measures. Employers therefore need to make sure that outsourcing service level agreements are tight and sufficient controls have been established along the payroll process to ensure timely and accurate payroll delivery.

Risk is transferred to the outsourcer according to the service level agreement (SLA). One issue that always needs careful negotiation is the appropriate split of risk for fraud and security, breaches as the potential costs could be significantly greater than the contract value.

Conclusion
Although payroll is often seen as a non-core business process, it sits at the heart of organisation and should not be underestimated in complexity and cost saving potential.

Payroll must be accurate, on time and secure. That is one of the key principles that organisations should not loose sight off when looking at making changes to their payroll management, the payroll organisation, the payroll processing and systems.

Responsibilities between finance, HR and payroll should, to the extent that segregation controls permit, be based on partnership no matter where in the organisation payroll is located to support these principles. Any payroll system must take the wider payroll scope into account as well as requirements from related business processes and functions.

When outsourcing or reviewing an existing payroll outsourcing contract, cost efficiency of payroll integration points, quality of service and risk SLAs should be considered to ensure best value for money.

About the authors
Bettina Pickering is a Managing Consultant, Andy Edwards and John Harrison are Principal Consultants at PA Consulting Group.