How to Budget for Employee Pay Raises

In this post, I’m going to outline a simple method that you can use to budget for your employee pay raises this year.

For over 30 years, I have helped my clients review the compensation levels of their employees and create a budget for expected increases.

The method I use factors in job descriptions, base pay, and the cost-of-living adjustment to create a budget for employee pay raises. Then a percentage of that budget is applied to each employee based on performance.

It’s straightforward and easy to do.

Let me show you how.

• Step 1: Create job descriptions
• Step 2: Determine your budget for employee pay raises
• Step 3: Use a performance review to rank employees
• Step 4: Allocate budget based upon performance

Step 1: Create job descriptions

No matter the size of your practice, it’s really important that you have clear job descriptions for each employee.

Why?

Because job descriptions define the baseline performance expectations and compensation level.

Job descriptions help provide a means for objectively evaluating an employee’s performance. And as we’ll see in a moment, it’s important that you have a process for ranking employees’ performance relative to each other.

In addition, each job description should have a defined salary range. This is a minimum and maximum salary that an employee can expect to earn in that role.

The minimum salary is what you might offer to a new hire who meets the qualifications, but has no previous work history in that type of role. They would be expected to make their way up to the maximum salary for their job description as they develop and get better at that job.

But in order to exceed the maximum salary, that employee would need to be promoted to a new job description with greater responsibility and a higher salary range.

Once you have clear job descriptions for each employee, then we can move on to building a fair and accurate pay raise budget.

Step 2: Determine your budget for employee pay raises

Start with a list of the hourly pay rates for all of your employees. For employees that are salary, divide their salary by 2,080 (40 hours/week x 52 weeks/year).

In our example below, all three employees are currently compensated within the salary range for their job description. The total hourly rate for all of our employees is $65.

	Job Description	Salary Range	Current Hourly Wage
EE#1	Receptionist	$30,000 – $45,000	$15
EE#2	Insurance Biller	$35,000 – $50,000	$20
EE#3	Hygienist	$55,000 – $80,000	$30
Total			$65

Next, you need to decide on a percentage that you will use to increase wages.

This isn’t an exact science. It’s really up to you to decide what you believe is both fair and fits within the overall budget for the practice.

I like to suggest that you look at the Cost-of-Living-Adjustment (COLA) for a good starting point. The COLA is used by Social Security to adjust retirement benefits for inflation. It’s based on the Consumer Price Index and adjusts based on how well the economy performs.

From there you might adjust the percentage up or down based on how well the business did and what fits your budget for the year.

In the table below, we did a simple analysis to see what different employee pay raise percentages would look like in real dollars.

	Hourly Rate Budget	Total Salary Budget
Current	$65	$135,200
+1%	+$0.65	$136,552
+2%	+$1.30	$137,904
+3%	+$1.95	$139,256
+4%	+$2.60	$140,608
+5%	+$3.25	$141,960

For our example here, we’ll assume that you decide to use three percent as the budget increase for employee wages. This means that there is $1.95 to allocate as hourly pay raises among our three employees.

Step 3: Use a performance review to rank employees

Some doctors prefer to give a flat raise across the board for all of their employees.

In our case, this would mean giving each employee a $0.65 raise ($1.95 / 3).

I don’t recommend that you apply across the board increases unless your employees are all performing similarly.

Raising wages by the same amount to everyone on the team does nothing to incentivize performance.

Instead, I would suggest that you allocate your employee pay raise budget to each employee relative to their performance.

This is where your job descriptions come into play. Each job description should clearly outline the duties and responsibilities required to meet expectations.

Then, when you do your annual performance review with each employee, they should be judged against what was defined in their job description. I suggest you adopt a 1-5 rating scale that looks something like this:

Performance Rating	Definition	Points
1	Unacceptable	0
2	Needs improvement	0.5
3	Meets expectations	1
4	Strong results	2
5	Extraordinary results	4

You can change the point system however you think is fair. What’s important is that you have a process in place to help you objectively rank each employee’s performance.

Step 4: Allocate budget based upon performance

Merit-based pay raises motivate and reward employees who embrace a culture of continuous improvement.

The points that an employee earns in their performance review is used to determine what percentage of the pay raise budget they will be awarded.

In our system, the points increase by a factor of 2 for each rating. This means that someone who earned a 5 on their performance review will receive a pay raise that is 2x higher than someone who earned a 4, 4X higher than someone who earned a 3, and 8X higher than someone who earned a 2.

Here’s how it would work in our example:

	Performance Rating	Equal Raise	Point Ratio	Adjusted Raise	New Hourly Wage	% Raise
EE#1	3	$0.65	1/5	$0.39	$15.39	+2.6%
EE#2	4	$0.65	2/5	$0.78	$20.78	+3.9%
EE#3	4	$0.65	2/5	$0.78	$30.78	+2.6%
Total		$1.95	1	$1.95	$66.95

Employee #2 and Employee #3 each received the same performance rating, so they get the same pay raise. Their raise is twice as much as Employee #1 who received a lower performance rating.

Conclusion

Now, I want to hear from you.

In this post, we described a simple method that you can use to budget for employee pay raises based on merit.

But it’s far from the only way to do it.

Do you give merit-based pay raises at your practice? Or do you believe that there’s a better alternative?

Let me know in the comments below.