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EMPLOYEE BONUS & INCENTIVE PLANS
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Employee Bonus & Incentive Plans
Before establishing an employee bonus, incentive and or profit sharing plan remember and
consider the initial bargain you made with the employee. They would perform certain tasks to a standard
defined by you and agreed to by them for a set dollar amount. Your pricing and profit structure is, in
part based upon that employee meeting the expectation defined in their part of the contract.
If an employee does all that is expected of them by that bargain their side of the contract is
fulfilled and the employee is owed nothing more than the wage promised. If an employee does all that
is expected and more, they have exceeded their contract and are deserving of some recognition or
extra compensation. If the expectation has not been fulfilled the employee has not lived up to their
bargain and actually owes you money. As was once said never pay for a dozen eggs and agree to
accept only 11. The same is true with an employment contract.
Well defined incentive and bonus plans should be based on the simple concept of award and
punishment. If you exceed stated performance standards the plan will provide an award. If you fail to
meet the performance standard the plan should provide a punishment. For example, an attendance
plan may provide for an extra paid holiday for an employee that has exceeded the attendance standard.
On the other hand, an employee who fails to meet the standard may lose a vacation day or be
suspended for a day without pay. As their absence has caused you to lose time and money, they should
share in the loss just the same way they will share in profits if they exceed expectations.
When establishing an Employee Incentive/Bonus Plan consider and incorporate into the plan
the following:
I.
Plan Objective
The objective of the Incentive Plan should always be to increase profitability by encouraging and
rewarding employees for working harder and more efficiently.
II. Concept.
Employee payroll wages and other associated tasks are built into your pricing structure either by
allowance under your general overhead expenses or by direct allocation as a cost of goods sold for
cost required to complete a task or produce an outcome. In both calculations the cost of each
employee’s time is based on specific job assignments and tasks that need to be completed within
certain defined performance standards. It is on these standards that the company profitability is based.
5 Fieldstone Lane Hampton Falls, New Hampshire – 603 601-2555 – [email protected] – www.MySBAdvisor.com
Helping Your Business Succeed & Prosper
If, as a result of an employee working harder and more efficiently, the tasks assigned, are completed
using less labor, equipment and or materials than originally projected or more is sold than originally
contemplated, the Company will either generate higher profits or have the opportunity to generate
more sales which in turn leads to higher profits. When an employee exceeds their performance
standards the Company should share a portion of that extra profit with that Employee as a reward for
their hard work.
Generally speaking, Bonus and Incentive plans can be managed at different levels.
1. The first is the individual. When an individual exceeds the performance parameters of their job
they should be rewarded for their effort in an amount that is commensurate with the monetary
benefit they have created.
2. The second is at the team level. When a group of individuals, working as a team, have exceeded
the performance parameters of their task assignment they should be rewarded for their effort in
an amount that is commensurate with the monetary benefit they have created.
3. The third is at the Company level. When, as a result of the combined efforts of the whole group
the Company has obtained profitability levels beyond the planned and projected amounts a
bonus should be provided to all that is commensurate to the additional profit created.
There are no hard or fast rules. A Company can implement incentive plans at any or all levels. What
is most important is that at whatever level it is implemented it produces results.
III. Basis for the Incentive.
An Incentive Bonus should only be based on the things an employee can control or influence.
For instance, a retail clerk does not control the price or the calculated profit of the items in the store.
The clerk, however, can influence the things and or amounts customers purchase. Likewise, an
equipment operator does not control the hourly rate or job price the Company gets for the machine.
The operator, however, does control how quickly the tasks assigned to that equipment get done and
to a certain extent the costs of maintenance and operation of the machine. The Incentive Bonus for
these two individuals could be based on the following:
A. Retail Clerk – The performance standard would be the average sale amount per customer
served. The incentive would be a set dollar amount based on the percentage of every sale
dollar in excess of the stipulated average customer sale.
B. Equipment Operator – The performance standard could be the cubic yards of material moved
per hour. The incentive would be a set dollar amount based on percentage of the time value
5 Fieldstone Lane Hampton Falls, New Hampshire – 603 601-2555 – [email protected] – www.MySBAdvisor.com
Helping Your Business Succeed & Prosper
saved (opportunity created) or actual job savings that resulted from the operator exceeding the
expectation.
Note that in both these examples the performance was defined by a metric that was connected to and
controlled by the employee. The bonus amount was, however, measured by the impact that particular
behavior had or could have on Company profitability.
.
IV. Bonus Calculation.
Each Employee should have defined performance parameters for the tasks that are assigned to them.
Remember your pricing and profitability is based on the employee performing those tasks within the
guidelines you established for the wage they agreed to accept.
The actual labor, equipment, and/or material costs associated with the defined performance
parameters be compared against the estimated labor, equipment and/or material costs used to quote the
price to be paid by the customer. If, as a result of the employee’s performance, the labor, equipment and
material expenses actually incurred are less than the estimate, and the profit therefore greater, an
amount equal to a percent of that excess profit amount should be set aside and accumulated for
distribution to the employee(s).
If the labor, equipment and material costs actually incurred, including additional costs incurred for poor
quality work, are more than the estimate and the profit therefore is less than anticipated, one hundred
percent (100%) of the amount of the loss (anticipated profit – the actual profit or loss) should be
subtracted from the bonus as the employee did not live up to their employment agreement.
V. Reporting & Distribution
For an incentive plan to be effective employees need to be kept informed as to where they stand.
Concurrent communication will allow them to adjust their behavior in order to receive the gain offered by
the plan. The amount they receive or do not receive should never be a surprise.
Likewise, distribution of the benefit should not be unnecessarily delayed. A delay in distribution will
cause employees to lose interest in the plan and hence defeat the objective of the plan.
The timing of reporting and distribution should be directly tied to the performance standards and
behavior that you are trying to influence.
VI. Conditions of Participation.
5 Fieldstone Lane Hampton Falls, New Hampshire – 603 601-2555 – [email protected] – www.MySBAdvisor.com
Helping Your Business Succeed & Prosper
Always define the conditions of participation. These conditions should be directly tied to the
performance standards and behavior that you are trying to influence; however, they can also be used to
influence other behaviors as well. A few examples of conditions of participation are shown below.
A. Only full time employees are eligible for the bonus.
B. To qualify for the bonus an employee must be employed by the company on both the first
working day of the period for which the bonus was calculated and on the day that the bonus is
actually paid.
C. To qualify for the yearly bonus an employee must be employed by the company for at least nine
consecutive months during the bonus period and be employed by the company on the day that
the bonus is actually paid.
D. All normal taxes and withholdings will be deducted from any bonus provided.
E. The Yearly Bonus is based upon the Corporate Year-end of June 30.
5 Fieldstone Lane Hampton Falls, New Hampshire – 603 601-2555 – [email protected] – www.MySBAdvisor.com