Rewards &  Incentives

Performance-Related Bonus Scheme

While it is possible to use performance appraisal for employee development and feedback purposes solely, many organizations wish to link the appraisal process to specific reward and incentive outcomes. This is a legitimate objective. Studies indicate that employees find the process of appraisal more satisfying and credible when it is linked to reward outcomes.

The examples given below are based on a performance appraisal system with a five-point rating scale and seven performance factors. (Why seven? Because the underlying method is based on the ANPAS performance appraisal system, which uses seven performance factors and five-point Likert-type scales. A rating score of one represents very poor performance, three is competent and five is excellent. This method of bonus calculation may be modified to suit any type of appraisal system involving multiple performance factors and scores.)

Brief Description
The first step in a bonus plan is to calculate the Bonus Fund (or budget). This is the amount of money that the organization is prepared to allocate for bonus use. Next, an average performance appraisal rating is determined for each employee. If an employee scores higher than a pre-determined level, he or she is eligible for the bonus. The size of the bonus paid depends on both the performance and the seniority of the employee. Finally, a formula allocates the money in the Bonus Fund to all eligible employees.

Full Description
There are four separate steps in the Bonus Plan -
1. Calculate the Bonus Fund
2. Determine Bonus Eligibility
3. Select Salary/Seniority Band
4. Calculate Individual Bonuses

1. Calculate the Bonus Fund
The first step is to determine the amount of money available to pay the bonuses.  It is suggested this amount be about 2.5% of the annual wage and salary bill. This amount is known as the Bonus Fund.

The figure of 2.5% may be varied to reflect the policies, needs and circumstances of each organization. For example, a percentage of profit may be preferred, or even a percentage of profit increase.

2. Determine Eligibility
To be eligible, the employee must achieve an Average Factor Rating of 3.40 or better. The Average Factor Rating is calculated by summing the ratings and dividing the result by seven.

Calculate Average Factor Rating:
= (sum of factor scores)/number of factors
=(4 + 4 + 3 + 3 + 5 + 3 + 4) / 7
= (26) / 7
= 3.71

In this example, an Average Factor Score of 3.71 would make the employee eligible for the bonus.

3. Select Salary/Seniority Band
There are three Salary Bands, S1, S2, and S3. Employees with incomes in the higher bands will receive proportionately larger bonuses. This is necessary to maintain compensation relativity and provide incentives to employees on higher incomes. It is up to each organization to decide how it will define the salary bands. As a guide, the proportion of employees in each Salary Band should be about S1 60%, S2 30%, and S3 10%. The most common approach is to define bands according to wage and salary cut-off points; for example:

S1... $0 p.a. to $40,000 p.a.
S2... $40,001 p.a. to $70,000 p.a.
S3... $70,001 p.a. and above

Another approach is to use job evaluation cut-off points to achieve the same result, or to group employees loosely into seniority categories, for example:

S1... Junior and non-supervisory staff
S2... Supervisors, specialists, middle managers
S3... Senior and top managers

The method chosen to classify employees into Salary Bands is not important, so long as it is systematic and reflects the general pay and seniority structure of the organization. 



S1 (lower)


S2 (middle)


S3 (upper)


4. Calculate Individual Bonuses
For each individual, the bonus is calculated by this formula -

Bonus formula for performance appraisal

This formula will fully allocate the amount of money available in the Bonus Fund, regardless of the number of recipients. If there are fewer recipients, the bonuses for each individual will be correspondingly bigger. For this reason, it might be wise to have a bonus cap of around 10% per individual. That is, the maximum bonus payable to an individual  should not exceed 10% of their regular wage or salary. This may result in a 'leftover lolly' problem, that is, money unallocated. Such residual amounts can be re-consolidated into general funds or re-used for bonuses in the next performance period. This is a matter of policy for each organization to determine.

There are fifteen employees in the Purchasing Department of a medium-sized organization. The gross annual wage and salary bill for the employees is $744,000. The Bonus Fund is set at $18,600 (2.5%).

Among the employees, seven have received Average Factor Ratings of 3.40 or better (therefore they are 'eligible').

 Employee Salary Band

































* rounded up

In John's case:
Bonus = (3 + 4.5) x 18,600 /(26.75 + 11) = $3,695

In Ahmed's case -
Bonus = (1 + 4) x 18,600 /(26.75 + 11) = $2,463

Payment of Bonus
While the bonus could be paid in a single lump sum, it is suggested that multiple smaller payments - bonus instalments - be paid throughout the next performance period (monthly instalments are ideal). A number of payments at intervals can do more to strengthen the link between performance and rewards than a single payment which may be all but forgotten in a short time.

It is recommended that the bonus be paid by way of a separate check, pay packet or deposit. The payment will lose much of its impact if it is simply consolidated with normal pay. Every separate payment is a reminder to the employee of the value of his or her personal effort, and serves to encourage the type of behavior that leads to superior job performance.

October 1, 2016

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