How to Calculate Employee Bonus Earnings

How to Calculate Employee Bonus Earnings

Employee bonuses represent a great solution for increasing productivity, uplifting employee morale and enticing people to perform over their quota.

Despite this, many small business owners hesitate to invest in an employee bonus program, fearing it will have a negative effect on their bottom line. However, with a carefully calculated program, you can show your employees how much your value their work and motivate them to step things up, making it worthwhile.

This article will provide you with a comprehensive insight into what an employee bonus is, what type of programs are available and how to choose the right program for your company.

What Is an Employee Bonus?

An employee bonus is compensation that an employee receives from their employer in a workplace setting. The amount of the bonus is an additional payment that complements their usual benefits or compensation, such as base pay or salary.

The bonus can be granted as an anticipated or predetermined motivational reward, or an unexpected one for increased productivity and performance.

While it's great practice to show employees that the exemplary work they are doing for the company is appreciated, motivation and productivity aren't the only reason for rewarding workers with bonuses.

Reaching longevity milestones can also be acknowledged with an additional amount to the worker's salary.

Employee bonuses are a great way to encourage employee satisfaction and loyalty, and can help to build an optimal employee-employer relationship. In fact, these incentives aren't only useful for retaining existing staff. They can also be a practical tool to entice future workers to join a company.

While bonuses can be based on different metrics, they always carry several benefits, and not only for the workers receiving them.

When applied correctly, a bonus program can significantly improve performance. And every time good performance is rewarded the employee will be motivated to continue their good work. They will stay engaged, so you won't have to worry about high employee turnover.

In the long run, all these factors improve the quality of the products or services the company provides. This translates to more satisfied paying customers and healthy financial growth of the company.

Types of Employee Bonuses

Depending on their purpose and the type of employee contract, bonuses can be divided into several categories. There are two main types of employee bonuses:

  • Incentive bonus
  • Performance bonus

Incentive Bonus

Incentive bonuses are additional payments or compensation awarded to a worker for accomplishing predetermined goals. Here are the most common types of incentive payments:

Signing Bonus (Golden Hello)

Signing bonuses, or golden hellos, are one-time payments presented to the most desirable applicants during the recruitment process.

The recruiter offers it to entice workers to join the company and it usually comes with the obligation to stay at the company for at least six months.

The recruiter may not offer the base salary the candidate is looking for but proposes a signing bonus that will make up for the gap.

They might offer to pay the expenses of moving the employee from another company or are simply eager to snatch the candidate with offers from the competitors.

Golden Goodbye

Golden goodbyes (also called golden parachutes) are bonus packages offered to high performers after their contract is terminated. These types of bonuses and severance compensation packages are typically included in the employee contract.

Apart from large sums of monetary compensation, the former employees may receive stock bonuses, ongoing insurance benefits and an addition to their retirement plans.

Retention Bonus

Retention bonuses are rewards received by employees either for staying with the company for a considerable period or despite offers from the competition. High performers are often offered this type of competitive pay, especially when working in a high-demand area.

A retention bonus is typically a one-time payment made through a pay rise unless the company has the financial means to provide a long-term raise for the worker.

Referral Bonus

A referral bonus is monetary compensation offered to current employees who help recruit new workers for an advertised position. This is generally practiced in fields where there are hard-to-fill positions for which the agency cannot provide the right candidate without an inside referral.

The amount is paid after the vacancy has been announced through adequate channels, the referred candidate has passed all stages of the recruitment process, has been hired and has started performing successfully.

Besides the hiring difficulty, the bonus amount is also dependent on several other factors. Some positions will garner higher incentives, and in some companies, diversity matters too.

Performance Bonus

Performance bonuses are meant to compensate employees for exceptional work based on success.

Spot/Discretionary Bonus

Employees who have demonstrated continued exceptional performance or secured a lucrative deal for the company are frequently rewarded with a spot (discretionary) bonus.

Typically, these bonuses aren't included in the employee contract. Companies often keep a discretionary fund that they can use for this purpose, which is a great way to secure recognition even in difficult times.

In addition, spot bonuses don't always come in the form of traditional payment/ They can be given as gift cards, extended annual leave or company discounts.

Team Bonus

Entire teams can be awarded for their collective performance growth over a predetermined period. Not only will these bonuses benefit the individual members, but they help to form a stronger team – leading to more efficient teamwork.

It improves overall focus for all the members and promotes collaboration for future projects. Team bonuses include profit-sharing, earnings-at-risk and gain-sharing plans.

Profit-Sharing Bonus

Profit-sharing bonuses provide workers with a percentage of the company's profit and are one of the most beneficial employee benefits.

The amount is typically calculated on the company's post-tax profit for a predetermined period. Therefore, workers only benefit if the company makes a profit.

The company sets aside part of its profit for this purpose, then distributes it to each eligible worker in cash or stocks. The amount they receive is determined by their title and base salary.

Commission Bonus

Commission bonuses are the most well-known employee compensation options, particularly in the sales sector. Each worker earns a predetermined amount after each successfully completed sale.

The amount they receive is detailed in their commission plan, which complements their base salary. There are several types of commission plans:

  • Base salary on top of commission – The employees are provided a commission that complements their base salary
  • Absolute commission plan – The commission is paid as a reward for meeting specific goals, such as obtaining new customers
  • Relative commission plan – A commission plan with a set target or quota, and to make the commission, the employees must meet the target
  • Territory volume commission plan – Employees can earn a commission based on their performance in a predefined territory
  • Straight-line commission plan – A commission is awarded based on the number of sales; the more someone sells, the higher their bonus will be
  • Tiered commission plan – Employees make increasing commissions based on their target and their ability to exceed it. Earning more and more after each deal they close over the quota encourages them to exceed their milestones.

Holiday Bonus

These bonuses are typically provided during the holiday time (usually over the winter/Christmas holidays) as an expression of gratitude for helping the company prosper through the year.

The amount can vary, but it's always a great motivation tool. It also ensures worker retention and productivity for the coming year. The entitlement for the holiday bonuses is typically included in the employee contract. Plus, the worker will receive a written explanation detailing which of their actions were rewarded.

How to Calculate Employee Bonus Earnings
How to Calculate Employee Bonus Earnings

How to Calculate Employee Bonuses with Examples

Let's take a look at how you can calculate the bonus pay for your employees for different types of bonus schemes.

Bonuses incentivizing sales can be calculated by multiplying the amount earned by the previously established bonus percentage.

The easiest way to determine sales commission is shown in the following example.

Let's say a salesperson makes a total of $50,000 in sales over a predefined period. The predetermined total bonus percentage for their contract for the same period is 10%. You will need to convert this into a decimal by dividing by 100 (which gives us 0.10). Now, you only need to multiply the total sales by the total bonus percentage:

$50,000 × 0.10 = $5,000

This shows that you will pay this particular employee a $5,000 commission for the period in question.

Team Bonus Divided Between Members

Team bonuses are typically based on a designated amount, which may be calculated before or after the completion of a project.

You will also need to determine whether the overall sum will be divided equally between all the team members, or whether individual bonuses will be allocated based on seniority, roles, tasks performed and other criteria.

The following example illustrates a team bonus calculation based on equal distribution of funds. Let's assume you have five employees working on a project, and you have $20,000 to give them as a bonus:

$20,000 / 5 = $4,000

The bonus calculation shows that you will give $4,000 to each of them. You can decide whether this will be paid as a one-time payment or distributed through the following months. In the latter case, you will need to divide $4,000 by the number of months you will be paying out the bonus to work out the monthly payments.

Salary Percentage

The best way to ensure all workers receive a bonus is to base it on their annual wages. To calculate a bonus based on salary percentage, you should check your employees' salaries.

For workers who earn hourly wages, this may require looking into the past year's figures and estimating the payments for this year.

For those with a fixed base salary, you will only need to look at the agreed amount in their contract.

If an employee earns $45,000 a year, multiply their predetermined bonus rate by their salary. Based on a 3% bonus rate, the bonus calculations are as follows:

$45,000 × 0.03 = $1,350

The employee in this example will receive a bonus of $1,350 on top of their annual salary. Again, you may determine whether this will be paid as a lump sum or distributed through the following months. In the latter case, you will need to divide the bonus amount by the number of months you will be providing the funds.

Retention Bonus

If the terms of a bonus agreement indicate that the bonus should be distributed in increments (instead of a flat, one-time sum), you must determine the amount you should pay and how frequently.

Let's say you have an employee who has been working for your company for years and is now being recruited by one of your competitors.

To retain them, you decide to offer a $3,000 retention bonus to be paid out over the next four months. Divide the total bonus amount by the number of months:

$3,000 / 4 = $750

So, your monthly bonus distributions for this employee will be $750 for the next four months.

Golden Hello Bonus

Golden hellos typically come at a flat rate – and are determined before the hiring process. However, if you can only pay out the bonus in increments, you should calculate the payout rate.

Decide over how many months you'd like to pay the bonus, then divide this number by the signing incentive amount. For example, if you are offering to pay a golden hello of $1,000 over the course of five months, your bonus calculation should look like this:

$1,000 / 5 = $200

This shows that you will need to pay a bonus of $200 for five months.

Frequently Asked Questions

This depends on whether they are still employed at the payment date and whether their contract includes the bonus entitlement.

If a worker has been receiving a discretionary bonus that isn't specified in their contract, they won't qualify for the incentive after handing in their notice.

However, if the employment contract links a worker's eligibility to qualify to the validity of the contract, they should receive a bonus as long as they are still employed.

That said, if they have handed in their notice and their contract was terminated before the bonus payment date, they will no longer qualify for a performance incentive.

Bonuses are calculated as percentages of an employee's base salary, so they are likely to grow with the increase of the base salary.

Personalized bonuses can be the best motivational tool for new employees who don't yet earn high base salaries.

In addition, higher base salaries imply seniority to other employers and your employees may be more likely to move on.

On the other hand, employee bonuses are not transferred with a job. With the right incentive, you will be able to keep your loyal employees for a long period, and they will be happy to continue to work for your company.

All types of employee bonuses are taxable as supplemental wages, at a rate of 22% (regardless of your employee's top marginal tax rate). However, as there are several different bonus programs, there are also options to deduct the taxable amount.

Depending on the type of program you are using, and what works for you and your staff, you can either withhold 22% from their bonus and pay it in a separate check, or add the amount of the incentive to their regular paycheck, with the taxes already calculated from them.

With a discretionary bonus, the entitlement for the incentive isn't included in the contract and a standard of performance is required for the bonus to start. After this is achieved, the employees receive a flexible amount based on the employee's discretion.

This carries the risk of the workers being unaware of the standards they need to meet.

However, with a non-discretionary bonus, the amount is based on defined performance criteria.

Employees know in advance how well they need to perform to receive the bonus, and the entitlement is often included in their contract. In this case, the employers are legally obligated to pay the incentive to each worker who meets the criteria.

There are several online tools that can automate the processes and animation of employee compensation and bonuses. They allow you to collect, store and even recover all the data needed to calculate incentives.

If you are a small company owner, you can use free software, such as Excel, which can effectively manage the incentive calculations of smaller businesses.

If your company is growing rapidly, you need to motivate your employees by continually raising their bonuses. In this case, your business will require a payroll management program that can handle more complex operations.

Personalized variable tools are also available if you are looking for specific types of services and have the budget to match the pricing.

Final Thoughts

If deployed carefully, bonuses can be just the motivation tool your employees need to increase their productivity level. Not only that, but many programs offer flexible options of payout format, something your staff will love even more.

Introduing an employee bonus scheme is an investment, but the guaranteed return on them can be can be a huge asset for your business. That being said, it's always a good idea to evaluate employee needs before choosing a bonus program.

An occasional re-evaluation is also recommended to ensure the existing program still yields the same benefits for your employees and your company.

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