Budget allocation is a major employee question in pay for performance plans

by on June 23, 2009 · 0 Comment POSTED IN: HR Info Center

Budget the full amount for pay for performance plans and awards to prevent problems

This is probably the most common question we get. “How do you fund the pay for performance plans?” and “How do I make sure that I can cover the bonus allocation and commitments to all the people?”

When you’re doing your budgeting, you should budget the full amount of individual awards in all of your pay for performance plans. You should budget target awards for target performance.

The target bonus for the CEO was 80,000. Well in your target budget then we should have accrued the $80,000 as a bonus payable. So, that if we have our target performance and our target bonuses and our budget, as we hit budget then we should be earning those targeted awards. The funding would be there to make those payments at year end.

Failing to budget for pay for performance plans does have its problems
Now obviously if it’s high to target, a lot of times companies – let’s say for example your bottom line target was $500,000 and your bonus accrual was 200,000. Well if you did not hit the 500,000 but say you were at 400,000, they would take that bonus accrual down by a 100,000 in that case. And the bonus funding pool would only be 100,000.

So, that’s the way you kind of estimate that. Now to the extent you have individual reward components like the example of a manager of the purchasing department, basically that whole incentive, if it’s $5,000, you may want to take all of those individual incentives and throw that full amount into the budget. Everybody is going to be looking to budget to pay for the incentive pay.
If you go through that process and you add all those up and it comes to some unreasonable number that there’s no way you can get in the budget, then you need to look at the probability of paying out the full amount Maybe some historical review will give you an indication.

So, for example, on your individual incentives in ther pay for performance plans, maybe historically you’ve paid out about 70% of that. So, you build that into your budget of 70% of the total individual awards. And then at least you have the funding there and paid for it.

Obviously, you can tie this to a variety of things. You can tie it to funding in excess of budget, you can tie it to – here is what we want to have as a shareholder, bottom line in return and anything above that, we’ll share 50-50.

You can have a ton of different funding vehicles. But the most common, one of the easiest one to implement is a target award for target performance. You just build both of those into your budget.

Edited remarks from the Rapid Learning Institute webinar “Incentive Pay Plan Blunders That Can Cost You a Fortune.” By Kevin Nussbaum and Ed Rataj

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