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Define Compensation: What It Is, The Different Types of Compensation, And Why It’s So Important—An Employer’s Guide

Define Compensation: An Employer’s Guide Define Compensation: An Employer’s Guide
min read
October 16, 2023

When it comes to running a successful small business, there are few things as important as compensation. A solid compensation plan will not only help your business become more profitable, but it will also help with employee retention—while a bad compensation plan will send top talent running for the hills (and straight to your competitors).

But what, exactly, is compensation? What role does it play in building, growing, and running a successful business? And how can you develop a compensation plan that serves both your business and your employees?

What Is The Definition Of Compensation?

Compensation is defined as the payments you give to your employees in exchange for their contributions to your business—for example, their time, expertise, knowledge, or skills.

Compensation includes cash payment (like an employee’s base salary or overtime pay) as well as non-cash payments (like the employer contributions you make to an employee’s retirement plan). 

Because small businesses need to hire a variety of employees in order to function, employee compensation is typically one of the largest expenses in running a business—which is why it’s so important to get it right.

Base Pay Versus Total Compensation

Often times, when employers think of compensation, they think of base pay—the hourly wages or salary that they pay their employees.

And while base compensation often makes up a large portion of an employee’s compensation package, generally, it’s not their total compensation—and it’s important to understand that difference.

As mentioned, compensation covers both cash and non-cash payments to employees; any way you compensate your employees would fall under the “compensation” umbrella. So, when you hire an employee, it’s important to consider their total compensation package and how that’s going to impact your bottom line—not just their base salary or wages.

What Are The Different Types Of Compensation?

So, how else might you need to compensate your employees outside of their base pay?

Some of the different types of compensation include:

When you’re building your employee compensation budget (and determining whether you can afford to hire a new employee, and, if you can, how much you’re going to compensate your new hire), it’s important to look at the entire compensation picture—not just the salary or hourly wage you’re going to include in their offer.

Laws Around Compensation

In addition to keeping your budget and profitability in mind, there are also laws you need to consider when determining employee compensation.

Some of the legal issues you’ll want to keep in mind when setting employee compensation include:

How To Develop A Compensation Plan For Your Business

Not sure how to develop a compensation plan that works for your business and your employees? Here are some tips to help you get started.

Use Compensation To Build A Sustainable And Profitable Business

Understanding compensation is an integral part of running a successful and profitable business—and attracting top talent to that business. And now that you understand the ins and outs of employee compensation, you have everything you need to develop a compensation plan that works for you and your team.

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