Raise vs. Bonus for Your Small Business Employees?

Employees are the backbone of every small business. They are the face of the enterprise and directly influence its success or failure.

Hiring and retaining top-tier talent is a key objective for business owners, and paying the employees is an important part of the recipe for success. Evaluating the pros and cons of raises versus bonuses and striking the right balance between the two can help a business owner achieve staffing goals while also maintaining a healthy bottom line.

Making money is the reason most people go to work. From the employee’s perspective, more is better. But for employers, more may not always be possible. Accordingly, many small business owners offer employee compensation packages that are made up of a mix of salary raises and periodic bonuses. This balance enables business owners to reward employees when business conditions are good and adjust variable costs to reduce expenses when business conditions are tough.

Some firms give out across-the-board raises each year, with every employee getting the same amount. Others vary the number based on individual performance. In either case, giving out raises results in a permanent increase in the cost of doing business.

To address this uptick in the run rate, the business owner should be working from a budget and setting aside enough cash to make sure business operations can continue as expected despite the increase in payroll costs. Companies with predictable and steadily rising profits may be able to do this with few concerns. Those with less predictable revenues, rising costs or variable business cycles may be more reluctant to permanently increase payroll expenses.

From a financial perspective, bonuses can be easier for business owners to manage because they are a variable cost that be reduced or eliminated if business conditions make it difficult or impossible to fund them. While the ability to minimize or avoid the expense is attractive from a financial perspective, it can be extraordinarily detrimental from the perspective of an employee’s morale.

Employees rely on their income to pay bills and put food on the table. Large, unpredictable fluctuations can be very disruptive and cause employees to seek employment elsewhere. Because of this, employers should take care to communicate to staff members that the ability to reduce expenses when necessary not only helps the company save money but also avoids the need to make staff reductions when business temporarily slows. In a well-run business, cutting bonuses can save jobs.

When determining bonuses, 3%–5% of annual salary is a fairly typical range for clerical and support staff. Managers could receive payments in the low double-digit percentage range, with executives in the mid-double-digit range. Senior executives at the highest levels may receive the majority of their compensation via bonus payments.

Bonuses can be structured to recognize individual merit or to reward collective success. Individual-merit–based bonuses reward top-producing employees for their individual efforts. Sales-based bonuses that give the most money to the person responsible for bringing in the most new business fit into the category. Production-based bonuses, such as those that give the most money to the person who answers the most calls or produces the most widgets, also fit in this category.

With a bonus based on corporate success, if the company hits its sales goals, profitability goals or other defined metric, all employees are rewarded. Under this system, employees often receive a predetermined payment amount that is based on the collective achievements of the corporation rather than individual performance.

Bonuses can be included as a recurring part of employee compensation packages or offered as one-time events to recognize significant milestones such as growth, profitability or longevity.

While cash bonuses are likely the most familiar form of bonus, there are other forms that may be worth considering. Offering employees an ownership stake in the company is perhaps the ultimate form of bonus. This can come in the form of an invitation to become a partner in the business, or via the issues of stock. Smaller companies that cannot extend such offers could still consider the creation of a profit sharing plan that makes a discretionary payment toward employees’ retirement savings.

Other possibilities include granting extra vacation days or awarding tickets to a sporting or cultural event, movie passes, or gift certificates to a restaurant, grocery store, or gas station. These small tokens of appreciation are available to even the smallest of businesses at a reasonable cost. (See also: 4 Unique Employee Benefits You've Never Heard Of.)

A great company values its employees and rewards them for their contributions to the success of the enterprise. This includes creating a compensation model that employees understand and ongoing communication with team members so that they realize their efforts are appreciated. (See also: Top 5 Ways to Retain Your Best Employees.)