Earning The Carrot

A development for many companies in a rather challenging economy is how to keep your operating expenses low yet, still provide compensation to employees that both keep them motivated and compensated for their efforts.

            The "Carrot" in front of performing employees has been a staple of many business models. But, in a bad economy it has become even more important. Many companies need to hit their profit numbers even during hard economic times. All the while, management needs to be kept motivated and focused on managing the company. Companies also need to provide for a reward system that compensates good managers for creative efforts that trickle down to bottom line profitability. We all know business profits flow from the top of the "profit and loss" statement in terms of sales revenues but, in hard times when sales are flat, profit can also flow down from trimming operating costs and by creating greater efficiency.

            One effective measure of performance I have had the opportunity to work with is  the concept of EBITDA. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization.  In theory it is a profit and loss statement that is the representation of everything management can be held responsible for. Typically, in many companies middle management does not have any control over interest, taxes, depreciation and amortization. But in theory everything else they do control. Once EBITDA is determined, then a percentage profit sharing plan can be calculated and distributed to eligible management if, they achieve target percentages.

            Depending on the company, the calculation of EBITDA can be adjusted for various factors that would negatively impact the comparability of EBITDA from period to period.  Thereby, making profit share calculations more stable. For example a company that is forced to make significant investments in repairs and maintenance to operating equipment could exclude those expenses as  part of their EBITDA in order to truly show management efforts.  At one client I had the EBITDA calculation changed from quarter to quarter depending on circumstances.  Both management and the owners handled the calculation with fairness and bonuses were routinely paid.

            One very important factor to note is each company that contemplates using EBITDA needs to have a good base line financial reporting system. You need to determine that point of reference from which to begin tracking management efforts and you need to establish clear cut and obtainable goals.