I have written extensively on the topic of performance-based compensation. That work focuses on the technician and office staff. I am being asked more and more about bonus plans for managers. In this article, I will show you how to create a simple plan that is easy to manage and provides protection to the company if financial goals are not met.
Sales Growth Drives Bonuses
We expect our management team to implement the financial plan laid out by the executive staff. This is usually the owner, president, or CEO. If most of the control your managers have is related to creating or managing sales volume, then we will base this plan on meeting our sales growth goals for the year.
Decide on a Bonus Amount and Work Backwards
Decide on how much you would like to bonus your managers if the company does as well as you hope. For now, do not worry about being able to afford these bonuses. Let us say that you have four managers, and you would be happy giving them a bonus equal to a 10% increase in their salary. The only requirement is that your company must meet its sales goals for there to be any bonus.
Create a Budget and Decide on Requirements
Using a budget and other data, decide on your annual sales (aka revenue or income) growth goal for the upcoming year. You may also start this process anytime during the year. We can begin the bonus plan during the start of any quarter. Be sure that your budget considers the cost of these bonuses.
Let us say we have four managers with a salary of $100,000. We will be (hopefully) paying out $40,000 in annual bonuses. We need to add that amount to our budget’s expenses (overhead). We then adjust our sales numbers to overcome the additional $40,000 expense and still generate the net profit we desire.
If we meet our sales goal, the managers get the bonus we anticipated. What happens if we exceed our sales goal? We should consider increasing their bonus by a fixed percentage. In essence, we will give them a portion of our sales increase without jeopardizing net profits.
Gross Profit and Net Profit
Why don’t we base all of this on gross profit or net profit? You could base the plan on either one. Be sure that the managers have control over gross profit or net profit. It is important that they have control over the factors that determine whether they will receive a bonus.
Gross profit is more meaningful than sales, so my preference would be to set this plan up to use gross profit. Adjust the percentages so that the bonus amount works out to be the same.
Create a Written Policy and Procedure
I have included a sample plan below as it would appear in our Operations Manual. Please read it very carefully and make changes as needed.
Management Bonus Plan Policy and Procedure
Let us first cover what annual sales growth percentage is acceptable for our company. The number we select is based on many factors, including our current sales volume, economic conditions, our financial resources, staffing, and the capabilities of our staff.
Classifying Sales Growth Percentages
15% = Poor
16% to 19% = Fair
20% to 24% = Good
25% to 28% = Very Good
29%+ = Excellent
Our Annual Sales Growth Goal
Our sales goal for 2021 is the same as 2020 plus 22%.
The Bonus Plan
We will pay eligible managers a bonus equal to or greater than 10%, for each quarter where our sales growth was 22% or greater.
Rules and Policies
1.Each quarter, our sales will be finalized by the 10th day of the following month. Bonuses will be added to the next payroll.
2. Bonuses will be paid only when our sales growth numbers are 22% or higher for each quarter.
3. Bonuses will be calculated based on what your annual salary was on the last day of each quarter. This rule favors the manager.
4. Minimum quarterly bonuses are equal to 2.5% of your annual base salary. Example: If we achieve sales growth of 22% for four straight quarters, your annual bonus will equal 10% of your salary.
5. For every percentage point above 22%, your annualized bonus of 10% will also increase by 1%. That causes your annualized bonus to be 11%.
6.If we do not achieve our annual sales growth goal, no bonus will be paid out for the fourth quarter. This is regardless of that quarter’s performance. This rule provides some protection to our company if there are some great quarters, but the annual sales growth is disappointing.
7.This bonus plan is subject to be changed without advanced notice. This is not a contract or a legally binding agreement.
Example Bonus Scenarios
To make the math easy, let us use a salary of $100,000 that does not change throughout the year.
1.If our sales growth is 21%, the quarterly bonus will be $0.00. We did not meet our sales growth goal.
2 If our sales growth is 22%, the quarterly bonus will be $2,500.00. The math: (100,000 x .10) / .25
3.If our sales growth is 25% (our goal), the quarterly bonus will be $3,250.00. The math: (100,000 x .13) / .25
4 If our sales growth is 28% (our goal), the quarterly bonus will be $4,000.00. The math: (100,000 x .16) / .25
Now that your bonus structure is set, are you ready to take a deeper dive into financial structure of your business? Visit EGIA.org/CBS-Financial to download a free training resources bundle that includes instructional video classes, how-tos for building a financial plan and setting appropriate benchmarks, the 7 Commandments for Financial Success, and much more!
James Leichter is a founding faculty member at EGIA Contractor University. Learn more about EGIA and Contractor University. He is a longtime HVAC contractor, consultant, and public speaker. Leichter is president and CEO at Aptora Corporation, a maker of contracting business management software. He is the editor of MrHVAC.com and BlackBeltContracting.com. James is a majority shareholder at RA Tax and Accounting, Inc.