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Compensation— Reward or Entitlement?

How to Make Your Program Cost-effective and Motivational
Most small business owners will say how their employees comprise their most valuable asset. In fact, very few businesses can succeed and grow without employees. Small businesses employ the largest segment of our country’s workforce, yet many business owners fall short in one aspect of effectively managing this resource: compensation.

Employee payroll and related benefit costs comprise the highest segment of overhead for most small businesses, averaging 40% or more of revenue. The new fiscal year is upon us and overall cost-of-living increases of 2% or more means business owners need to look for increased revenue sources and opportunities for cost containment.

Here are some options to consider to more effectively compensate your employees, and to reward and motivate them while keeping these costs in check.

Compare and Contrast

You first need to compare your employee numbers, compensation, and benefit levels with those of your peers and the market. Your competitors may not be open to sharing their numbers with you but your company’s CPA firm may be a valuable resource. Also, surveys are published every year by various industry groups on both a national and regional level. These surveys can give you an indication of whether your employee costs and personnel levels are generally in line or above the norm, overall.

Next, list each employee by job description, full-time equivalent status (FTE) and compensation expressed in terms of total annual compensation and hourly wage.

Compare this with survey data to find out where each individual is within the compensation range. Highlight those individuals at or above the upper range. This is important because you need to periodically assess whether you are paying your employees fairly relative to the market, whether each employee’s duties are still appropriate, needed and commensurate with compensation, and whether you are over or understaffed.

Pay Raises

Across-the-board pay raises are generally not a good idea. They don’t motivate employees, they send mixed messages, and eventually lead to overpaid individuals and disproportionate compensation levels. Pay raises should be granted on an individual level and only after a performance review.

A pay raise may be given to bring compensation to a level within the market range of that position if performance is as expected and the individual has achieved a noticeable and expected improvement in professional development.

A pay raise is also appropriate if an individual assumes more responsibility than originally assigned and obviously if one is promoted to a new position. Cost-of-living increases are appropriate but may not necessarily have to be made on top of other aforementioned increases. For example, an employee is paid $13.50 per hour and the market range for that position is $13 to $17.

If a 50-cent raise is granted to bring that employee higher within the market range based on performance and development, this represents a 3.7% raise which exceeds the cost-of-living increase of 2.5% and therefore, no further adjustment is necessary.

Once an individual’s compensation reaches the upper market range, you need to weigh carefully any pay raise beyond that upper limit because, if the individual is now above the range in the following year, the cost becomes compounded. You can’t just cut pay and benefits. You need to inform the employee of the condition and plan over time to get this back into the market range.

Bonus or Entitlement?

Bonuses are an important part of an employee-compensation program when utilized appropriately. Unfortunately, they are often misapplied, overused, and lose their effectiveness. Prior to implementing a bonus program you need to make sure your base pay and benefits are relative to the market, as discussed above. If they aren’t, fix them. A bonus program is not a substitute for an inadequate base compensation package.

If a company gives an across-the-board bonus year after year, employees see this as a part of their recurring compensation and in some cases spend more or plan in anticipation of receiving it. The “Clark Griswold” syndrome comes to mind and pity the owner who doesn’t come through with that annual Christmas bonus. He may end up at the bottom of the planned family swimming pool. I’m not suggesting you immediately scrap small goodwill holiday gestures, but consider the following. A bonus program should be communicated as a not necessarily recurring but discretionary reward for past exceptional performance. It should be based on profitability and, ideally, targeted performance goals.

A bonus program should be aligned with company goals, such as increased sales, quicker inventory turnover, decreased sick time and overtime, more-efficient customer flow, decreased order processing and customer waiting time, reduced customer write offs and lower days of revenue in accounts receivable. These should be specific and directed to appropriate departments.

For instance, an accounts receivable clerk can’t impact sales volume or inventory turnover. A bonus pool should be budgeted, based on targeted levels of achievement and communicated to the employees so that they understand how it works and what they have to do.

Actual monthly and year-to-date results should be posted so employees can monitor progress. Manager and supervisor bonuses should be based on the results of their departments. This promotes individual and group effort. Part of the pool is awarded across the board for team effort and part is awarded to selective individuals based on relative work ethic, achievement, and attitude.

An individual that stepped up to the plate above expected levels is rewarded for that particular achievement. Employees must know that each year stands alone and there will be good years and better years — the better years count.

Occasionally missing a bonus period can be as motivating as receiving the bonus because it reminds employees that these are not entitlements and must be earned. Look closely at your bonus program and find out if it needs restructuring. It can save you wasted dollars, promote efficiency and productivity, and motivate employees.

Employee Benefits

Employee-benefit costs have soared in recent years and, in some cases, are more important than the hourly pay rate. Some companies hand out to each employee an annual benefits value sheet that shows the dollar value of every employer provided benefit. In doing so, employees are made aware of their total compensation package, which is important if they are comparing to employees of other companies, which they do.

Offering additional fringe benefits can actually be less costly when adding these in lieu of or in addition to a smaller pay increase. The following are employee benefits that, properly structured, can be less expensive in the long run than employee raises and yet may be worth the same amount dollar wise to employees than a pay raise because they are tax free:

  • Pre-tax flexible spending accounts
  • Short-term disability insurance
  • Group term life insurance
  • Increase in employer portion of health and dental insurance premiums
  • Increase in employer match on 401(k) s
  • Dependent care plan

These are less expensive than comparable pay raises for two reasons. First, they are not subject to payroll taxes and second, if the employer cost is in terms of actual dollars rather than a percent, their cost will not compound annually like a pay raise will. One employee administrator who was already earning at the upper compensation range for her position was given the choice of a lesser raise or long-term disability insurance coverage. She opted for the disability coverage.

Reduce Staff Through Attrition

Companies that find themselves overstaffed may find it difficult to identify certain individuals to terminate, especially if it results in retained employees picking up their less-than-full-time duties. This could create unwanted morale problems.

However, individuals retiring or otherwise voluntarily moving on often provide an opportunity to reorganize and reassign duties and job descriptions to save the costs of a full-time position. It may require a parttime replacement or it may require a small increase in pay for affected individuals but the savings could be substantial. Base your department managers’ bonuses on targeted staffing levels and watch what happens.

Control Overtime

As indicated above, lower overtime targets could be a basis for bonuses. Overtime is sometimes necessary, especially when someone is absent or in peak business periods. However, in most businesses, overtime is excessive.

Have your accountant or bookkeeper tabulate last year’s overtime hours and related cost as a starter. In monitoring overtime, don’t forget to also track the hours and costs of outsourcing to temp agencies.

A decrease in one may result in an increase in the other. Savings could be achieved by allowing employees to take up to a week of overtime earned in additional paid vacation, but check your state labor laws first.

Restructure Retirement Plans

The laws and regulations governing the design and coverage of employer retirement plans has changed significantly in recent years, yet many companies have the same plan structure in place. More-recent safe harbor rules and discrimination restrictions have enabled some employers to change their plan design so as to enable owners to maximize their annual contributions at a lesser cost overall.

This may be done without reducing the current benefit to non-owners. If your retirement plan has not changed, it may be worthwhile to have a benefit plan consultant review your current plan design and employee census to see if you could benefit from a new plan design.


Business owners should view their employee compensation and benefits as a program to promote the well-being and objectives of both the individual and the organization. Hopefully you will find one or more useful ideas in this article to make your compensation program more cost effective, rewarding and motivational.

James B. Calnan, CPA, is a partner with Meyers Brothers Kalicka, P.C., Holyoke, Certified Public Accountants and Business Consultants; (413) 536-8510.