Do you have employees in your small business? Managing payroll effectively and efficiently is one of the biggest responsibilities for any business owner. The question is — should you use a separate payroll management system, or keep everything in one place with your accounting software, such as Xero accounting software?
If you are thinking about using an all‑in‑one solution, then learning how to set up Xero Payroll is the best starting point. In this article, I will guide you step by step through the Xero Payroll Setup in Australia. We will look at how to set up payroll correctly. In the second part, we will explore how to manage timesheets, leave, superannuation, and Single Touch Payroll (STP).
Payroll is one of the most important jobs for any business owner. Employees must be paid correctly, tax rules must be followed, and reporting to the ATO must be done on time. Mistakes can cause stress for both employers and employees. That is why setting up payroll properly in your accounting software is so important. By following a clear step‑by‑step guide, you will understand exactly how to start and keep your payroll running smoothly.
Why Choose Xero Payroll?
Using separate software means extra cost and more time requirements. Initially, if you can manage your accounting in one place, it will be easier to handle. Xero Payroll is designed to save time and reduce compliance risks. It connects pay runs, timesheets, super payments, and ATO reporting in one system.
With the right setup, Xero helps you:
- Pay employees on time and correctly
- Calculate PAYG tax and superannuation automatically
- Managing timesheet, leave request and approval
- Stay compliant with Australian payroll laws
- Report directly to the ATO through STP
For small businesses, this means less paperwork and more confidence that payroll is done right.
Step 1: Activate Payroll in Xero
If you are already using Xero accounting software, you know how simple it is to set up and manage your accounts. The Xero Payroll Setup is just one part of the overall system. If you are setting it up for the first time, don’t worry — the process is straightforward. All you need to do is log in to your Xero dashboard and follow the step‑by‑step guide. Go to Business → Payroll settings. Enter your organisation details, ABN, and financial year information.
This step connects your business details with the payroll system. Without it, you cannot process pay runs or report to the ATO.
Step 2: Set Up Pay Calendars
This refers to how often payroll is processed. It can be weekly, fortnightly, monthly, or a mix of these. If you have different groups of employees, you can create multiple pay calendars to suit each group.
For example:
- Casual staff may be paid weekly.
- Office staff may be paid fortnightly.
- Managers may be paid monthly.
Setting up calendars correctly ensures pay runs are smooth and predictable.
Step 3: Create Pay Items
Employees are usually paid for their normal working hours as stated in their contract. In addition, they may also receive payments for overtime, allowances, or have deductions applied.
When you set up pay items:
- Make sure ordinary hours match the employee’s contract.
- Add overtime rules if employees work extra hours.
- Include allowances such as travel or meal expenses for office work purpose.
- Add deductions like salary sacrifice or union fees.
If only ordinary hours are included, you do not need to add extra pay items. However, if there are any additional payments or deductions, you must include them in this step.
Step 4: Add Employees
Now it’s time to add your employees’ information one by one. To do this, go to Payroll → Employees → Add Employee. For each employee, enter the following details:
- Personal and contact information
- Employment type i.e., full‑time, part‑time, casual
- Tax file number (TFN) and tax‑free threshold status
- Super fund details
- Pay rate and ordinary hours
Once Xero payroll setup is done, Xero can automatically calculate PAYG tax and superannuation.
Step 5: Managing Timesheets in Xero
Employees are paid based on the hours they work, so keeping accurate time records is essential. If you have been tracking time manually, you can now manage the entire process through Xero accounting software.
In Xero, employees can enter their timesheets directly. Once submitted, payroll administrators can review and approve the timesheets before processing pay runs.
Tips for Timesheets
- Set clear cut‑off dates for submitting timesheets i.e., every Friday before 3PM. If the Friday is holiday, then prior to that day. For casual employees, after close of work each time.
- Encourage staff to use the Xero Me app for easy entry.
- Integrate with time‑tracking tools like Deputy, Tanda, or Clockify if you need detailed rosters.
Step 6: Setting Up and Managing Leave
Employees are entitled to get the leave and you can maintain this record in the same place. Employees can request leave online through the Xero Me app or web portal. Managers or payroll admins can then approve or decline requests.
Once approved, Xero automatically deducts the leave balance and adjusts pay in the next pay run. This avoids manual changes and ensures compliance with National Employment Standards (NES).
In Xero, you can set up leave types under Payroll Settings → Leave. Common leave types include:
- Annual Leave
- Personal/Carer’s Leave (Sick Leave)
- Long Service Leave
- Unpaid Leave
- Public Holidays
Each leave type can be configured with:
- Accrual rate (e.g., 4 weeks per year for annual leave)
- Accrual method (per hour, per pay period, or per year)
- Whether the leave is paid or unpaid
- Whether it appears on payslips
Make sure leave entitlements match the employee’s award or contract and comply with the Fair Work Act.
Step 7: Managing Annual and Long Service Leave
Annual Leave
Xero automatically accrues annual leave based on the rules you set up in the system. These balances carry forward each year, so employees can continue to use their entitlements over time. Adjustments can also be made if leave is taken in advance or if it is cashed out, provided this is done in line with Fair Work requirements.
Long Service Leave
Long service leave usually applies after seven to ten years of service, depending on the rules in your state. In Xero, you can set up a custom leave type to track this entitlement. The system allows you to use accrual rates per pay run, such as 0.01667 hours for every hour worked in South Australia. It is important to reconcile these balances periodically with HR records to ensure accuracy. Even though long service leave accrues slowly, recording it in Xero from the beginning provides transparency and helps you stay compliant.
Step 8: Superannuation Made Easy with Xero Auto Super
Superannuation can be complex when employees have different funds, but Xero’s Auto Super feature makes the process much easier. Xero automatically calculates super at 12% (from 1 July 2025) during each pay run. At the end of each quarter, you simply go to Payroll → Superannuation, select the unpaid contributions, and create one batch payment. Once you authorise the payment, Xero’s clearing house, Beam, distributes the funds directly to each employee’s super fund.
Quarterly super deadlines:
- 28 October (July–September)
- 28 January (October–December)
- 28 April (January–March)
- 28 July (April–June)
Step 9: How Xero Calculates PAYG Tax
Xero uses the latest ATO tax tables to calculate PAYG withholding automatically. It takes into account the tax‑free threshold, any HELP or HECS debt, and working holiday maker rates where applicable. Each pay run records the withheld tax under PAYG Withholding Payable, making it ready for your next BAS.
Step 10: Register for Single Touch Payroll (STP)
STP is mandatory for all Australian employers. It means you must report employee pay, tax, and super details to the ATO every pay run.
In Xero, go to Payroll → Single Touch Payroll. Connect your Xero file to the ATO. This only needs to be done once. After that, every pay run can be reported directly.
Single Touch Payroll (STP) Reporting
STP reporting is simple in Xero:
- Finalise your pay run.
- Click File to ATO.
- Review and submit the STP report.
- Check the status as “Accepted” once the ATO confirms.
At the end of the financial year (by 14 July), mark the final pay event as “Finalised.” Employees can then see their income statements through myGov to file their annual tax return.
Best Practices for Smooth Payroll
To keep payroll running well:
- Review pay items, super, and tax settings quarterly.
- Reconcile payroll liability accounts monthly.
- Schedule Auto Super payments a week before the due date.
- Set reminders for STP reporting and BAS lodgements.
- Back up payroll reports regularly.
Final Thoughts
A correct Xero Payroll setup is the key to saving time, staying compliant, and keeping employees happy. Once set up, Xero does most of the heavy lifting — from calculating PAYG tax and super to reporting to the ATO in real time.
If you find the process complicated, you can complete training on Xero Payroll to build confidence in your Xero Payroll setup.. You may also consider seeking advice from an experienced accountant or tax consultant to ensure everything is set up correctly.
