Employment law

Everything you need to know about incentivising staff with a bonus scheme

Everything you need to know about incentivising staff with a bonus scheme. Image of employee receiving a bonus | Crunch

Table of contents

    A good, fair and well-designed bonus scheme can be a perfect way to increase your staff’s productivity.

    If you decide to set one up, what do you need to consider?

    Designing your scheme

    When designing your scheme, start by asking yourself why you want one to begin with:

    • Do you want to change your employee’s behaviour so it follows your company objectives/culture?
    • Do you want to motivate and retain all (or key) staff and reduce replacement recruitment costs?
    • Do you want to recognise staff’s performance or positive behaviour that's above the norm?
    • Do you want to increase productivity and achieve more sales/customers? If so, do you want to reward staff for getting new business, developing existing business, getting sales from a particular company/sector/industry, or increase your customer’s minimum spend?
    • Do you want to reward someone for meeting a specific objective/project?
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    When you understand what you want to achieve, consider what factors the bonus scheme should be based on:

    • Individual performance
    • Team performance
    • Overall company performance
    • A combination of individual or company performance.

    Keep in mind that employees may not be able to influence team behaviour, so this may not motivate them. Some staff may not be able to alter their own behaviour to reach the bonus targets, either.

    Bonus Schemes can be single-factor or multi-factor. A single factor scheme will focus on one specific goal, e.g. an individual employee achieving more sales. A multi-factor scheme includes other goals and is multi-layered (just try not to make it too complicated).

    Be careful with your contractors, as you may muddy their employment status by including them in an employee bonus scheme.

    Bonus scheme structure

    How will you measure performance? Make sure you document your criteria so everyone is clear. Make realistic goals/objectives/triggers to be reached, which can be adjusted over time. For example:

    • Increased customer satisfaction
    • New customers bringing ‘good’ sales
    • Successful delivery of a large project
    • Financial performance
    • Management skills
    • Team working
    • Productivity and output,  extent of workload
    • Quality of work and overall excellent performance
    • Safety record
    • Attendance at work

    If the bonus is designed to target new sales, give staff their own targets to reach and the bonus will only be paid if he/she reaches them (a certain sales figure).

    To devise an effective scheme, you need to understand the employee’s activities and what’s involved. You then need to agree how their performance is going to be measured.

    Don’t set targets that are too easy to achieve, or that are impossible to achieve – consider how easy it is for you to get new customers and the amount of work that’s needed by your staff to secure new sales. For example, for new sales, a realistic target may be to improve revenue by 5-10% over a year. It could otherwise be based on the need to make four sales a month, so anything over four sales generates a £X commission/bonus.

    Consider also what timescale you want to have for your staff to earn the bonus. It can be a monthly, quarterly or annual bonus. It’s often better to set short-term (quarterly) goals and compensate regularly, as this is more attractive to the employee, which often motivates them more. Quarterly also allows you to evaluate what the employee is doing and make adjustments to the scheme and its priorities if necessary. Annual bonuses are used when schemes are based on business profit, for example. You could also offer an “end of financial year” bonus or a Christmas bonus.

    You'll also need to decide when to pay the bonus. Will it be one, two or three months after the end of the bonus period? This is important for sales-related bonuses - you want to ensure you're not paying out bonus money on business you may not have been paid for yourself!

    The other tricky question is how much to offer as a bonus. The amount must be meaningful and ‘matter’ to the employee. The amount must be manageable for you on a financial front (so they don’t bring in new business and you pay it all back to them). It should only be paid when the costs of employing the employee and their overheads and the bonus are covered by the new business. It must be relative to their annual earnings and their role.

    Bonuses can be:

    • A percent of salary
    • A flat rate payment
    • A percent of their new sales
    • A percent of sales based on expectations
    • A percent of gross profit of their sales
    • A percent of invoice value
    • A split of gross profit (25/75, employee gets 25%).

    Profit related bonuses should include a threshold profit level that must be reached before any payments are made.

    Bonuses should ideally be uncapped to drive further sales/performance. If you set a capped bonus (e.g. you can only earn £X bonus per period), once the employee has reached their target, they may stop trying or slow down.

    To design a self-financing system, you need to consider what sort of increase you need and at what profit. Also, do you know what your industry norm is for bonus levels? Your decision must be based on your normal margins/profitability.

    Some Employers offer complicated bonus schemes that ‘weight’ several factors. Others offer schemes with a sliding scale of commission (e.g. profit up to £3,000 generates a 10% commission; profit between £3,000-£8,000 generates 20% commission; profit of £8,000 upwards generates 30% commission).

    Make sure your scheme isn't too complicated to administer; it must be easy and not time-consuming for you. Bonus schemes work best when the employee can easily calculate what he/she is going to earn.And finally, put it in writing.

    Employment law considerations

    Put all the details of the Bonus Scheme in writing so the terms are easily understandable. Make sure the scheme is separate to their contract of employment so it can be easily reviewed and amended or updated as necessary. You should evaluate the scheme regularly to see if it's producing the results you want. Make sure you have plans in place in case targets aren't being reached.

    Generally, bonuses can be ‘guaranteed’ or they can be ‘discretionary’ (paid out only at the employer’s discretion), but this may not produce the motivation to earn it that you require. Another type of ‘discretionary’ bonus is when a bonus will be paid but the amount to be paid will be discretionary (e.g. depending how much financial objectives are met). If you do this, you must make it clear.

    Ideally the bonus scheme should be described in writing as discretionary, non-contractual, reviewable and that it can be withdrawn by the company at any time.

    On a similar employment law note, however, making a bonus ‘discretionary’ rather than contractual may not stop it having some form of contractual effect. If a bonus has been paid for several years, the employee could argue they have an implied contractual right to it.

    Bonuses can also be described as ‘variable’ if its value can change from one period to the next.

    When designing the scheme, another important thing to consider is what happens if an employee leaves. Make it clear in writing whether they'll be entitled to receive a bonus payment that's due during their notice period; think ahead, as this is especially important if they're moving to a competitor or you've dismissed them.

    You can stipulate that bonus payments are conditional on an employee being employed by you and not serving notice (where notice is given by either party). If you pay them in lieu of notice, you need to decide whether they will be entitled to bonuses in that situation too.

    Any regular bonuses you pay must be taken into account when calculating ‘average’ holiday pay. More details are available here. Bonus pay can also have an affect on calculating a ‘weeks’ pay for some statutory benefits.

    Disadvantages of a bonus scheme

    Over time, employees may come to expect additional cash, rather the bonuses acting as a recognition for performing above and beyond the norm. In the long run, it may become a less effective motivational tool (another reason to regularly review your scheme).

    What if the scheme fails to achieve the change/actions you required? Will you adapt it or scrap it?

    If you are an Employer and need ongoing professional help with any staff/freelance issues then talk to Lesley at The HR Kiosk  – a Human Resources Consultancy for small businesses – our fees are low to reflect the pressures on small businesses and you can hire us for as much time as you need.

    Please note that the advice given on this website and by our Advisors is guidance only and cannot be taken as an authoritative or current interpretation of the law. It can also not be seen as specific advice for individual cases. Please also note that there are differences in legislation in Northern Ireland.

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