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For many, compensation is a straightforward concept. If you are the employer, you should pay your employees for the service they have done for you. When you are an employee, you must acquire compensation for whatever job you do.

However, it is not as simple as that.

For it to be fair, companies have to use a compensation system, which is for both monetary and non-monetary benefits. But how do you come up with the right number? What are its components?

Most of all, why is it important?

What is the Compensation System

A compensation system is the sum of all the benefits provided to employees. It includes both direct (basic pay, commissions, etc.) and indirect (life insurance, health benefits, etc.) monetary and non-monetary benefits they get.

Compensation is synonymous with salary and wage, which are the most common type of payment.

The salary is a fixed annual amount compensated to an employee. On the other hand, wage pertains to the specific sum paid for each hour of work. For example, you have an annual salary of $60,000, and it is paid in monthly installments of $5,000, while your friend has an hourly wage of $15 for his job.

Different Types of Compensation

Different types of compensation exist among industries. Companies often offer a package to their employees which will include two or more of the following:

  • Basic Pay – The salary or wage of the employee.
  • Commission – A percentage acquired when an employee reaches a particular quota or effectively does a specific task.
  • Overtime Pay – An hourly wage added to the basic pay when the employee works beyond their hours.
  • Housing/Travel/Meal Allowances – A fixed amount given to an employee per day, per week, or per month that covers their meal, travel fares, and accommodation while working with a company.
  • Benefits – include vacation and sick leaves, health benefits, taxes, retirement, and more.

Bonuses, merit pay, profit sharing, and stock options are also types of compensations.

How to Set Compensation

 Setting compensation is an essential part of the business. You do not just come up with a number when you are offering someone a job. There should be a reliable basis for the sum of the compensation package provided to the employees.

To set compensation, follow these steps:

  1. Define the job such as its purpose, responsibilities included, required skills and knowledge, and educational level needed for it.
  2. Price the job. Using a salary survey information from at least three reliable sources can help you do this.
  3. Determine what the job’s value to your company is. It is typical to pay higher for more valuable positions.
  4. Consider your organization, particularly the budget, when setting up a compensation package to guarantee it does not take a hit on your company’s finances.

Why is Compensation Essential?

Perhaps the most significant importance of compensation is that it boosts the employee’s morale. Imagine going to an 8-hour work every day without receiving anything or barely making enough to pay your bills. No one would want to stay with such a company.

If you are making money for the organization, it is only fair you get compensated for the work you have done.