Home Column Andi Gray: Determining the right amount for a bonus

Andi Gray: Determining the right amount for a bonus


andi grayWe’re having that conversation about what to give for bonuses. No bonuses are bad for morale. I’m worried that if people get too much, they could sit back and take things easy for a while and that would be bad for productivity and profits. How do we get it “just right”?

THOUGHTS OF THE DAY: Use bonuses to give the company more flexibility as revenues and profits go up or down from one year to the next. Do a reality check on salaries first before deciding on bonuses. Check the trends on overhead payroll vs. revenue and cost of goods sold payroll vs. revenue ratios. Reward overall company performance to get everyone on the same page. If you have a 401k plan, check to see if bonuses are included in matching funds. Use a budget to stay realistic.

If you’re not sure how company revenue and profits will trend from year to year, use bonuses instead of raises to reward people in good years. In down years, the financial burden on the company can be lessened as you cut back or eliminate bonuses altogether.

Before committing to a bonus strategy and amount per person, check on each position’s salary. In low unemployment cycles, salaries tend to rise. Make sure your salaries are competitive. Are you seeing more turnover lately and if so, is it due to people getting offers of better income and opportunity elsewhere? If so, it’s probably time to increase the amount of base salary you’re paying. Establish minimum, median and maximum salary amounts and job, and rate employees as entry level, qualified or highly skilled for the job they’re assigned to do.

Take a look at overhead payroll — overall company carrying costs. Compare overhead payroll without and with bonuses to revenue, gross profit and net income. These ratios should all be holding steady or dropping. If the ratios are rising, figure out how to get more revenue and gross profit to cover rising overhead costs before throwing out bonuses.

Separate payroll for employees essential to your operations — doing the work of serving your customers. That’s cost of goods sold payroll. Check on the ratio of COGS payroll compared with revenue. Is it trending up, down or the same vs. last year? You want the ratio to be down or constant. If the ratio is up, productivity has to go up to justify increased salaries and bonuses. Consider investing in technology and process improvements to get the ratio down, before throwing around significant bonus amounts.

Rather than hitting the bank account for a big annual bonus distribution in one month, consider dividing up bonuses into quarterly or monthly payments. To make bonuses more meaningful shorten the linkage between actions, results and rewards. Make sure your compensation plans are written to correctly describe the practice and include a clause that says people must be employed and in good standing in order to earn bonuses. Tie bonuses to overall company revenue growth and profit improvement, to get everyone focused on the essential goals.

If bonuses are part of matching funds in your 401k plan policy, make sure to calculate that as part of your total bonus pool and then work backwards to the amount of individual bonuses to be paid out.

Build a budget to see the overall picture of how things should play out. Include numbers for revenue, cost of goods sold, overhead expenses, loan payments, investments in infrastructure, building cash reserves, paying taxes and rewarding shareholders an rewarding employees. Make sure it all adds up so that you can pay employee bonuses and still have funds left over to grow and protect the business.

LOOKING FOR A GOOD BOOK? Try “How to Design Productivity Incentive Bonus Plans: A Practical Guide to Installing Performance-Based Productivity Incentive Plans (Industry Incentive Compensation Plans, Book 2)” by Dale Arahood.

Andi Gray is president of Strategy Leaders Inc., StrategyLeaders.com, a business-consulting firm that teaches companies how to double revenue and triple profits in repetitive growth cycles. Have a question for Ask Andi? Wondering how Strategy Leaders can help your business thrive? Call or email for a free consultation and diagnostics: 877-238-3535, AskAndi@StrategyLeaders.com.

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