Productivity-Based Compensation (“Bonus”) Principles

R. F. Willeford, MBA, CPA/CFP
rickw@willefordcpa.com  

1. General principles:

            a)         Remember, any bonus system is somewhat arbitrary. So you want to be sure to test your formula under various scenarios and see if it produces the kind of bonus figures you are comfortable with.

            b)         Remember that a bonus system should be simple, understandable and possibly be monitored throughout the month.

            c)         A bonus should be attainable, or folks will lose interest in the program.

            d)         The system should be based on a moving average to smooth out peaks and valleys.

            e)         A bonus can arguably be based on Production and/or Collections, Net Income or on keeping total wages at a predetermined overhead percentage. 

                        (i)         Production/Collections have the advantage of satisfying item 1(b) above. The worksheet is based on this approach.

                        (ii)         Basing a bonus on Net Income is conceptually preferable in a business where the manager can control both revenues and expenses, a “profit center”. However, in a dental practice, the staff has no real control over expenses, and the doctor can even manipulate expenses to avoid having a bonus.

                        (iii)        Shooting for a target percent, such as 22% overhead for wages, is probably OK. A problem can arise if your wages already exceed this percentage, and yet you want to implement a bonus system anyway in an effort to get the production up.

2. You need to decide what percentage figure to use to calculate the Bonus Pool amount. 20% is a typical figure.

3. How do you determine the Strike Point? If this is your first time for having a bonus, I would look at last year’s average Collections/Production and add at least an amount to represent your average fee increase. You might then add another 5-10% for true growth. Presumably, by the end of a year, the staff should be getting regular bonuses (if growth continues). At the beginning of the second year, you should increase the strike point by an amount equal to the average fee increase and perhaps by an additional amount of growth you are trying to achieve. Meanwhile, you give the staff raises to replace some or all of the prior year’s bonuses they have been getting.

4. You can either base the system on Production or Collections, or an average of the two.

            a)         Most doctors’ knee-jerk reaction is to base it on Collections. (“If I don’t collect it, I can’t afford to pay a bonus!”) While that is somewhat true, remember that you can always base the bonus on x% of Production, where x% equals your historical collection percent. If that is 96%, then you could base the system on 96% of Production.

            b)         Unfortunately, the staff can’t really influence Collections a lot (other than the front desk person). Since they CAN influence Production, it may be fairer to base the system on Production (or 96% of Production.)

            c)         An advantage of the Collection approach is that you might be able to ignore brief periods when the office is closed. For instance, if the office is closed for two work days due to continuing education trip by the doctor, the Collections keep flowing. Under the Production approach, you have to decide if you should base the bonus on an average DAILY Production figure. This would eliminate folks from complaining about the doctor being absent from the office too much.

5. You may want to limit the maximum amount of money that goes into the bonus pool for a particular month. For example, let’s say you have a huge month due to one big case, and Collections/Production is $30,000 over the Strike Point. At 20%, that would mean that 20% x $30,000 = $6,000 goes into the bonus pool. Your protocol may state that there is a ceiling of $4,000 for any one month. However, I would keep the full $30,000 figure for the next three months as you calculate the moving average. So a huge month still indirectly helps the bonus.

6. How will you handle an additional new staff person? As soon as you add to the size of the staff, everyone else’s bonus goes down! You may want to phase a new person in to the bonus over, say, 12 months. For instance, a new person would only get 1/12 of a share of a normal bonus the first month, 2/12 the second month, etc.