Is it Better to Reward Performance with a Raise or a Bonus?
(Depends which side of the cheque you’re on.)
Hiring the best employees is a difficult task, and an essential part of running a successful business. Retaining these employees is every bit as important. You want to keep the best working for you, and employee turnover can be costly. One key to keeping your employees, and keeping them happy, is ensuring you are giving them fair compensation. This includes increasing compensation when the situation merits it. Two ways to increase employee compensation are through a salary increase, a raise, or with bonuses. So which way is best, and for whom?
Any increase in compensation is a good way to incentivize employees. From an employers point of view, bonuses are often the best way to do this. They can be easier to handle financially since they’re a variable cost, with payment tied to specific outcomes, like increased sales or production volumes, for example. Since the payout varies according to the success of the company, and in some cases the individual employee, a bonus can be reduced or eliminated if business conditions make it difficult or impossible to pay them. The variable cost structure of a bonus package helps business owners during times of low sales or production volumes. Pay raises are permanent, but bonuses keep payroll costs lower when the revenue isn’t there to pay them. Also, bonuses can be set up as a short-term incentive, for example a sales campaign. A three-month sales initiative to bring in new business or a business with seasonal production increases, for example, could be tied to a bonus system. By incentivizing employees during specific periods, a company can maximize its revenue and profits during a critical time of the year.
From the employee’s perspective, there are a couple of things to keep in mind about bonuses. First, and most positively, if the bonus system is structured on individual performance, this essentially puts the amount they can earn in their own hands. They control their own destiny. However, before they go spending this new found cash, they should find out how it will be taxed as bonuses are generally taxed less favourably than regular income whether it be salary or hourly wages.
In contrast to bonuses, raises can be riskier for the employer because once workers get an increase in salary, companies are committed to paying them more for as long as they work there. Even if a company decides not to give raises in future years, they are still required to keep up with preexisting salaries. Also, because certain benefits, like pension-matching dollars, are often tied directly to salary, increasing salaries can cost companies in other ways. But let’s keep in mind you’re looking to retain your best employees. Besides helping them plan and budget for their monthly expenses, and helping them keep up with the cost of living, an annual raise helps boost morale and ensures that long-time employees are rewarded as they should be compared to more recent hires. And if there are bonuses tied to salary, an increased salary results in a bigger bonus.
Well that depends on a bunch of variables and the unique situation of every company. While bonuses may be attractive to an employer due to their variable cost structure, they may not be enough to retain your top performers due to tax issues and uncertainty year to year. On the other hand, a small percentage raise each year can be less costly than paying bonuses that may fluctuate with sales or production numbers. But remember this, annual raises are a permanent increase in the cost of doing business. Because payroll is often the largest expense for a company, it’s important that business owners determine whether the company generates enough revenue and monthly cash flow to meet the increased payroll expenses. It doesn’t have to be one or the other. The secret is in finding a balance that works for you and your employees.