Difference between Fixed Salary and Variable Salary

Salary or the total target compensation consists of fixed and variable proportions. Thus, determining the fixed and variable pay proportions helps in the pay-mix decision. Fixed pay is suitable to enable an employee to live comfortably. Performance-linked pay is an incentive to exceed expectations, performance standards, and goals.
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This flexible component is usually paid when the company achieves certain milestones. The percentages in the two blocks vary with experience. The greater the experience, the higher the proportion of the flexible pay.

What would be the ideal salary mix in determining fixed to variable salaries?

Pay mix ranges usually are 50:40, 70:30 or even 75:25. This varies depending on the industry, product or service, business segment or department, employee’s position in the hierarchy, the complexity of the job and the company’s position in the business cycle. Increasing flexible pay portions helps control fixed costs while providing a competitive pay package. Flexible pay directly links pay to performance. Getting a fix on these factors helps employee retention, prevents attrition and motivates employees.

Employees in sales and production have a higher proportion of their salaries paid as performance-linked salaries. People in finance, administration, and Human Resources have a higher fixed component. All line function employees have a higher variable salary proportion than fixed pay. All support function employees have a higher fixed emolument compared to performance-linked income.

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What is a Fixed Salary?

Fixed pay in cost-to-company refers to the fixed amount paid by the employer to the employee in exchange for services received in the form of a fixed salary. Fixed pay is the accrual salary mentioned in the salary slip, which includes the basic wage and multiple allowances. This indicates that the employee has worked on all business days of the month and taken sanctioned leave according to the company’s HR policies.

Fixed salary includes basic pay, dear allowances, house rent allowance, conveyance allowance and other special allowances. Deductions are made from this salary towards Provident Fund contributions and Tax Deduction at Source. Creating reports, budgets and other tasks not directly related to boosting the company’s revenue are remunerated through fixed pay.

The employers’ pay scales and salary ranges recognise the level of education, knowledge, skill, and experience required to perform the job. Salaries for executive-level positions usually are higher compared to lower-level posts.

Salaries for jobs are affected by additional demographic and market-led factors. The availability of jobs, people with the requisite skills and educational qualifications, CTC of the employee in his last job and pay scales at peer companies are considered while deciding the salary of an employee.

Features of Fixed Salary

A fixed salary is given to employees regardless of their job performance. Since it's a guaranteed amount, it gives the employee a sense of security. If you work on a fixed salary and are looking for a new place to rent verifying your income when getting an apartment might actually give you an advantage. However, it may cause a lack of motivation among some employees as it doesn't offer additional rewards for high-performance.

What is variable Salary?

Performance-linked pay scales are a talent appreciation monitor and a great morale booster. It prevents stagnation and encourages employee growth. Variable salaries may be paid quarterly, half-yearly or annually.

Features of Variable Salary

1. The variable salary depends on factors such as the employee's ability to meet targets, work completion, and the overall performance of the company.
2. The possibility of performance incentives tends to encourage employee motivation, potentially leading to increased earnings.
3. Variable pay retains employees as they can earn more by improving performance.

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How is performance-linked pay structured?

Incentives: Incentives can be structured when the employee attains specific targets within a defined period. Incentives could be a percentage, a flat figure, depending on sales volume or attendance metrics.  Incentives are common in customer-facing industries like finance or insurance.

Variable salaries are based on a company’s cost-benefit ratios, budget and employee recognition. Some companies also offer merchandise, employee discounts, travel allowances and holiday packages. Profit-sharing and management incentives are short-term incentives. Long-term incentives include employee stock option plans, promotions and partner tracks.

Bonuses: Bonus criteria is a surprise and not known in advance. Bonuses or the quantum of bonuses are an unexpected surprise for the employees. These include annual bonus, signing bonus, holiday bonus and profit-sharing bonus.

Recognition: Recognition involves cash or awards for employees who display exceptional performance. Training Programmes, sabbaticals, workshops and fellowships are other means of recognition. Employees may even be sent for professional skill development or higher education at the company’s expense if required.

Companies may also have specific policies to calculate variable compensation. In the annual budget, certain amounts are forecasted as performance-linked amounts, and they are recorded when the actual payments are made. It is a trial and error process and employees’ variable emoluments may evolve with the passage of time.

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Determining the salary mix for different companies

A growing, entrepreneurial company with variable sales and income streams may have a higher level of variable pay with lower fixed base income levels. In boom phases, the company can ramp up the payments of incentives and bonuses to reward employees for their performance achievement, whereas in slack times, low fixed salary payments enable them to control their costs.

A more mature company with a steady stream of sales and profits without too much seasonality creeping in can tilt the mix in favour of fixed pay structures.  

Key takeaways

Determining the proportions between fixed and variable salaries is company-specific. There cannot be a one-policy-fits-all situation. Variable payment is an evolutionary process refined by the company’s HR department over time. Complete transparency and accurate measurement of performance are the two cornerstones of evolving such a policy.

Employees who have a high degree of performance-linked pay may not be able to do accurate financial planning. Employees may also suffer burnout with overwork in case of high variable emoluments.

Frequently Asked Questions

Q: What is the main difference between fixed salary and variable salary?

A: The main difference lies in their structure. A fixed salary is a set amount of money an employee receives irrespective of their performance or the company's profitability. In contrast, a variable salary is performance-based and may fluctuate depending on the employee's performance, the achievement of targets, or the company's overall performance.
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‍Q: Can a salary be both fixed and variable?

A: Yes, many compensation packages include both a fixed and a variable component. The fixed part is the guaranteed salary, while the variable part is performance-based and could include bonuses or commissions.
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Q: How does a variable salary motivate employees?

A: A variable salary structure can motivate employees as it directly links their performance and effort to their potential earnings. If an employee knows that meeting or exceeding their targets could lead to higher earnings, they are likely to be more motivated to perform well.
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Q. How can companies effectively communicate variable salary components to employees to ensure understanding and transparency?

A. Companies can organize regular meetings and workshops to explain variable salary components clearly. They should provide detailed documentation, including examples of how variable pay is calculated. Regular updates and an open-door policy for questions ensure transparency and understanding.
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Q. What are the best practices for setting performance targets that are fair and achievable, yet challenging enough to motivate employees?
A. Setting fair performance targets involves aligning them with company goals, ensuring they are achievable yet challenging. Involving employees in the target-setting process promotes buy-in. Regular reviews and adjustments based on feedback help maintain motivation and fairness.
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Q. How do companies manage the impact of variable salaries on employee financial stability and planning?
A. Companies can offer financial planning assistance to help employees manage the uncertainty of variable pay. Providing a stable base salary with clear guidelines on how variable components are earned helps. They can also offer training on budgeting and financial management to support their financial stability.