Should You Compensate Employees Based on Performance?

Employee compensation comes in many forms, like hourly wages, salaries, and commission payments. As an accountant or firm head, you may have toyed with the idea of compensating your employees according to performance and productivity. This can be an effective strategy for keeping employees motivated, but it can also have pitfalls if you don’t plan correctly. To create an effective performance-based-compensation plan, start by determining what your objectives are for your company, and turn those objectives into realistic goals for your employees.

Why Compensate Employees Based on Performance?

To put it simply, your employees are going to be more engaged if you give them a reason to be. Employees who get paid the same amount of money for their working hours, regardless of how much they’re actually getting done, don’t have much incentive to work smart, try out novel strategies, or contribute to overall company growth. While younger, newer employees might be more engaged at first, that engagement can level off or even dip if there’s no reason to continue working at the same level.

Performance-based compensation can help to boost productivity in your office among all your employees, and better productivity often equals better profit. Offering increases and bonuses to employees who are consistently productive and efficient can create a working environment in your firm that favours strategic, efficient work and better engagement overall.

Structuring Performance-Based Pay

One option for a performance-based incentive structure is profit sharing. In a profit-sharing model, an employee’s pay increases when a company’s profit margin increases. Employees have an obvious incentive to improve overall company profits. You can choose how often you give out bonuses depending on how often you calculate your profit margin.

Annual bonuses are common, but some firms go with a quarterly or even monthly schedule. A monthly bonus system might work well for sales-based companies. For your accounting firm, quarterly or annual bonuses are probably the best choice, as this gives you time to figure out how new clients or business quarters fit into your bottom line.

The profit margin of your accounting firm is tied to the number of hours your employees spend doing productive, billable work. These are called billable hours. In many firms, the formula goes something like this:

  1. An average firm bills roughly 1,400 hours annually per employee
  2. An average firm collects roughly 90 percent of the amount it bills
  3. Assuming an annual salary of $50,000, each employee generates about $3,400 in annual profit

Going by this information, there are two metrics by which a company can increase the profits generated by each employee:

  1. Improving the percentage of billed fees that are collected
  2. Improving the number of billable (productive) hours worked by an employee

While the first metric has more to do with the quality and reliability of your clients, by improving overall employee performance, you can increase the number of billable hours your employees work. For every 100 additional billable hours that an employee works, you stand to increase profits by several thousand dollars annually.

Remember that performance-based compensation doesn’t include overtime pay. In fact, if used effectively, a performance-based pay program may greatly reduce the number of overtime hours being worked. The goal is to get your employees to work more efficiently within regular working hours, accomplishing tasks faster, not necessarily to just “do more work.”

Standard Payment vs. Productivity Bonuses

An average accounting firm can institute a performance-based payment scale on the following three points:

  • A competitive base salary
  • Bonuses for productivity
  • Bonuses for company growth

Be wary of using bonus incentives as substitutes for strong employee salaries. Your employees’ basic salaries should still be competitive enough to allow bonuses to be treated as bonuses rather than the missing percentage of a fair wage. Employees should feel financially secure even when they don’t hit those bonus targets, or when the company’s profit margin doesn’t allow for profit sharing.

You might pay out a productivity bonus as a percentage of increased profits annually. To figure out the amount, take the net amount that your firm bills for an employee’s time, minus the employee’s base wage (multiplied by 2.4 to get the break-even amount) and divide the remainder by two. For example:

  • Your firm has a few employees making $50,000 per year
  • In one year, your firm brings in $156,000 per employee
  • Multiple $50,000 by 2.4 to get $120,000
  • $156,000 – $120,000 = $36,000
  • $36,000 / 2 = $18,000

Based on this formula, each contributing employee is entitled to an $18,000 annual bonus for productivity. Bonuses for company growth are even simpler to calculate. If your employee helps bring on a new client, simply pay that employee 10 to 20% of your net revenue from that client.

Implementing a Performance-Based Compensation Plan

Make sure you’re setting attainable bonus goals for your employees. Attainable goals help increase employee engagement and productivity by creating a system of effort and reward. Company goals that are too abstract or simply too difficult can create extra stress for your employees, which decreases engagement and motivation.

For instance, maybe you want to grow your firm’s annual revenue by 10%. Think about that 10% in realistic terms. How many new clients do you need to acquire? How many more billable hours do you need to work? Translating an abstract metric into solid, structured goals helps your employees better understand your firm’s mission, which can lead to better employee engagement and more satisfied employees overall.

The biggest advantage of performance-based pay is improved employee engagement, which can mean increased profits and growth for your business. Before you implement any performance incentives, meet with your employees at every level to find out what type of goals can work for your people and address their concerns.

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