VIRTUAL HR DEPARTMENT – COMPENSATION AND BENEFITS: BONUS PLANS

Bonus Plan Documents

Virtual HR Department

Compensation and Benefits

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When implementing an incentive or bonus plan, an organization must consider a number of issues. First, in addition to a market-competitive base-salary plan, it is important that employees’ total cash compensation remains market competitive as well. The ratio between base and variable/incentive pay has to be given consideration; in addition, some types of jobs (e.g., sales) will normally have a higher level of variable income than others (e.g., production work).

Implementing a ratio significantly outside of what is normal for the industry and type of position could have a negative impact on recruitment and retention. Next, the behaviours and measureable performance results that are key to the success of the organization must be determined. Finally, value has to then be assigned to various levels of contribution/results in order to create a formula for calculating incentive awards that is clear and understandable to employees.

With respect to bonus plans, the most common way of doing this is to align the bonus payment structure with overall business results, team results (if applicable) and performance appraisal ratings, as was shown in the Merit Increases section.

Typical bonus program payouts are on an annual basis, based on the financial and performance results of the fiscal year. Payouts can be made based on the results of shorter periods, such as semi-annually or quarterly. This does create more administration workload and can lessen the effectiveness of the program as a retention tool. If an employee has less potential bonus money to leave behind if they resign, it makes the decision to leave easier. It also makes it easier for companies to offer signing bonuses to offset the bonus money that the employee is leaving behind. If that number is higher, a competitor is less likely to want to pay it out in order to hire the employee away from you.

Annual Bonus Program – Creating an Annual Bonus Program

Establish the award targets for the various levels of employees you have. You may choose to simply split your workforce into three groups, Non-management, Management and Executive, or use the different salary bands you have established. Typically, the higher the level an employee is in the company, the higher the percentage of pay the employee can earn via bonus (and has at risk if they don’t perform personally or do not lead the company profitably).

Using the type of salary band structure from Salary Bands – Example 1, in the Base Salary section, the following chart illustrates a typical award target distribution (this example has been expanded to include higher levels not shown in the salary bands example). As in the Merit Increase section, it is recommended that the award be based on the target salary as opposed to the current salary:

Salary Band Award Target
1 4%
2 4%
3 4%
4 5%
5 5%
6 6%
7 6%
8 8%
9 10%
10 12%

Next, determine what levels of financial results versus business targets or plans will trigger bonuses being paid, or what percentage of the award targets will be paid. If it is financially possible for your organization, it is recommended that bonuses be paid on a pro-rated basis for results that are below, but close to meeting the business plan targets for the year. This way, if there are a couple of bad months in the beginning or middle of the year, employees won’t be giving up on working hard to attain their bonuses because they know it will be impossible for the company to meet the business plan targets. It is also a great practice to reward your employees at a higher level if company performance surpasses the business plan targets by a notable level. Through having the potential to share the rewards of a great year for the company, employees will be motivated to continue pushing performance levels, even if they know a couple of months before the end of the year that the company has met it business plan targets. The following chart shows an example of this approach:

Company Results versus Plan Bonus Multiplier
Less than 90% 0%
90%-99% 50%
100%-110% 100%
111%-120% 120%
121% or more 150%

Finally, you will need to determine a similar scale of multipliers based on Individual performance levels. As was outlined in the Merit Increase section, it is advisable to link these multipliers to performance appraisal ratings, providing a higher level of bonus to employees who meet and exceed performance objectives. Once again, a fixed multiplier can be used or a range can be established providing managers with some flexibility to differentiate between employees who may be in the same Salary band and have the same performance rating, but where it is felt that some deserve slightly more reward than others.

Performance Rating Individual Performance Multiplier
Exceptional (E) 150%
Quality – High (QH) 125%
Quality – Solid (QS) 100%
Quality – Developing (QD) 50%
Improvement Required (I) 0%

Performance Rating Individual Performance Multiplier
Min. Default Max.
Exceptional (E) 140% 150% 160%
Quality – High (QH) 115% 125% 135%
Quality – Solid (QS) 90% 100% 110%
Quality – Developing (QD) 25% 50% 75%
Improvement Required (I) 0% 0% 0%

Now that you have determined each element, you can put them all together to calculate individual bonus amounts using the following formula:

Award Target x Company Results Multiplier x Individual Performance Multiplier = Bonus Percentage

Bonus Percentage x Target Salary = Bonus Payment

Bonus Payment Calculations

Salary Band Minimum Salary Target Salary Maximum Salary
4 $28,250 $34,000 $37,500

Example 1

Salary Band 4 Award Target = 5%
Company has succeeded in meeting business plan target, therefore Company Multiplier = 100%
Employee Performance Rating of QS, therefore Individual Performance Multiplier = 100%

5% x 100% x 100% = 5%
5% x $34,000 = Bonus Payment of $1,700

Example 2

Salary Band 4 Award Target = 5%
Company results of 95% of business plan target, therefore Company Multiplier = 50%
Employee Performance Rating of QH, therefore Individual Performance Multiplier = 125%

5% x 50% x 125% = 3.125% 
3.125% x $34,000 = Bonus Payment of $1,100

As done in other examples in this section, the bonus payment was rounded up to the next $50 increment from $1,062 to $1,100.

In the box to the right, you will find an Annual Bonus Worksheet and an Annual Bonus and Total Cash Compensation Calculator. The worksheet will allow you to do the bonus calculations as shown in the two examples above. Formulas have been pre-loaded into the Bonus Percentage and Bonus Amount columns as well as the Totals row at the bottom of the worksheet. The calculator will help you to summarize and project the costs associated with the bonus payments you determine through the process outlined above. Formulas are pre-loaded in the Total Cash Compensation column as well as the Totals row at the bottom of the calculator.

Project-Completion Bonuses

When critical projects or those that will have a significant duration are undertaken, organizations sometimes promote successful delivery of project objectives by offering project team members specific financial or non-financial bonuses (such as extra vacation days) for the project being delivered on-time, on-budget and at the desired level of quality.

Project-completion bonuses also serve as a financial retention tool and decrease the likelihood of employees assigned to the project resigning to move to another employer.

Retention Bonuses

During times of critical importance to the company, where employee turnover would have a very negative impact, organizations sometimes offer employees a bonus simply for continuing to be an employee to specific future dates. These bonuses are sometimes a lump-sum payment at a date that could be a year or two in the future or can feature a payment schedule during that multi-year period.

These were offered quite frequently to IT professionals in the last couple of years leading up to Y2K, but can be offered at any important time for the company, or as an ongoing program to attract and retain all or specific groups of employees.