What we're talking about

An employee bonus scheme – often referred to as an employee incentive plan – is a way of rewarding your team for doing a great job. What you offer can vary, from more vacation days to equity in the business, but the most common incentive is extra cash. Bonus plans are a great way to motivate employees and increase engagement. They also make the business more attractive to potential job applicants, so you could attract a higher caliber of talent.

Business owners and managers may think that these incentive plans are only for the benefit of the employees but, in the long run, the performance of the overall business will be affected by how the scheme is designed and implemented. Although there's a range of different bonus schemes – such as signing-on (a sum paid to a new employee), ad hoc (an unplanned, on-the-spot recognition) or referral (when a staff member introduces a job candidate to the business)  – this guide will focus on annual bonuses.

How many companies offer annual bonuses?

Bonuses are pretty common, with 33% of companies in the US offering year-end bonuses. And that number is up 3% from before the pandemic, as companies try to tempt people back into work. In the UK, bonus payments are at a nine-year high, as businesses turn to bonuses as a way of helping staff with rising costs without having to commit to new inflationary pay deals. Bonus payments this year made up more than 7% of average earnings, the highest figure since 2013.

With a looming global recession, you might think that you don't need to do much to incentivize your employees to keep their jobs. But, unless you keep your employees happy, there'll be a huge exodus of talent once the choppy tides subside. So, you need a highly motivated workforce – which is where a bonus scheme comes in.

Things to note

There are many different approaches. One popular method is having an individual bonus plan for each employee's achievements and goals. This gives the employee complete control over whether they get a bonus – and the bonus level they reach. Or, you could run a bonus scheme for teams or departments. This gets the whole group working in tandem to achieve their goals. Based on the time and resources you have available, decide which type of bonus best suits your company.

Keep it simple. A bonus needs to make business sense – you don't want to raise your employees' hopes only to dash them. So, make sure you know – or can accurately estimate – how much money you'll have available for the bonus plan. This could come out of your annual profits or be built into your budget. If you're unsure about whether you'll have enough money to give your employees a bonus, make sure that you outline a ‘profit gate’ in the bonus plan – and that your employees all know about it. Profit gates are common for many bonus plans – they mean that if a certain level of profit isn't met, then no bonuses will be paid.

Communication is key. The biggest mistake to avoid with any bonus plan is to not communicate it effectively with employees. Make sure you have a clearly written document that's accessible to everyone at your company. It should include how the plan is structured, what the targets are and how they're measured, as well as your commitment to attainability and fairness. Be transparent about what you're doing and what the scheme is trying to achieve.

It needs to be fair. To eliminate rivalry between departments or job types, bonus programs need to be fair across your company. If you're rewarding people on an individual basis, make sure that everybody gets something. You can do this by having different levels of bonus, where the lowest bonus is very achievable. This will motivate low performers to step up and do better to get a higher bonus in the future.

How to set up – and implement – an employee bonus scheme.

1. Decide if this is right for your business. Try to understand what your financial constraints are – as an early-stage business, your revenue might be unpredictable to start with.Calculate how much your bonus scheme will cost – if you offer everyone a 10% annual bonus or one month's extra pay, your payroll cost would increase by 10% or 8.3% respectively. You could also consider one-off bonuses as an alternative. 

2. Speak with your team. Figure out how motivated they are by financial reward or if some other kind of incentive might be more suitable. Some people might want more vacation days or more equity in the company. If a financial reward seems the route to take, find out if your employee bonus plan can match their individual goals.

3. Write down your business goals. Write down what you're trying to achieve by introducing a bonus scheme. These will be tangible (and achievable) targets. Then you can identify certain steps or milestones that need to be reached along the way. Consider laying this out for your team at the start of the year, so that they know what they're aiming toward.

4. Set individual goals. As well as company-wide goals, try setting individual targets for employees. This way, people know how they can actually impact their bonus. A blanket bonus for everyone within the company based on annual profit may be less motivating than an individual bonus based on specific employee goals. Targets should be measurable and quantifiable – stay away from anything vague. For example, instead of ‘increased standards’, go for ‘has completed X number of projects’.

5. Outline the reward amount. There may be industry standards that you can base your bonus policies on – and you can build on these if you want to become a destination company in your sector. Bear in mind that the financial reward needs to be a strong enough incentive to make people want to achieve it, whether it's a percentage of their base salary or a fixed additional amount. Your team won't be too happy if they've spent a year working really hard only to discover that the bonus amount is much smaller than they expected. Being upfront and transparent about numbers keeps everyone on the same page.

6. Pay on time. There are few things more disheartening than working diligently all year, hitting the requirements and then not receiving your bonus on time. If the bonus is the reward for the work done in a certain period, it should be paid at the end of that same period or during the next period.

7. Regularly revisit. Check in regularly on your employee bonus scheme to set limits and make adjustments – especially when budgeting or making financial forecasts. There are a few ways you can adapt your bonus scheme to make it even more aspirational for your team, like creating multiple bonus levels. Then, try to revisit your employee bonus plan at least once a year. 

Key takeaways

•  A well-planned and coherent employee bonus scheme is a good way to motivate your team and drive company performance.

•  Your bonus plan should be clear and easily accessible for anyone in your company to understand what's required of them.

•  If you're setting high expectations, you need to meet them, too. That means paying bonuses promptly and in full. 

Level up

Perspective. This guide by Early, a magazine from HR consultancy Bright + Early, explains employee payment and incentives, including the philosophy behind variable compensation like bonuses and commissions. 

Example. Toy brand LEGO has set a good example of how to pay fairly. During the pandemic, itrewarded its team after a bumper year of lockdown profits with bonuses and three days' extra holiday.

Tool. Payroll tools likePaycom orWorkday are great for small businesses that want to set up and run their own bonus schemes.

A version of this article was published in the Courier Workshop newsletter. For more deep dives into essential business concepts, sign up here.