November 27, 2024
5 mins read
Fixed and variable pay are both important parts of an employee’s compensation. While the amount of fixed pay remains constant month after month, the amount of variable pay can change considerably based on predetermined criteria. Such criteria can be based on an employee’s output or a company’s performance.
The key components of fixed pay are an employee’s base salary, various allowances (HRA + special allowance + TA + medical allowance), PF contributions, and gratuity.
The main objective of fixed pay is to provides predictable income for employees. Meanwhile, variable pay is meant to incentivise employees so that they work hard and produce more output.
Fixed pay and variable pay form the part of an employee’s overall compensation. The amount of fixed pay remains constant from month to month. However, the amount of variable pay can vary from one month to another.
No matter how much an employee works and how his organisation performs, the amount of fixed pay remains fixed in most cases. Meanwhile, variable pay’s component changes based on certain criteria, like an employee’s output, a business’s performance, etc.
This article explains the key differences between fixed and variable salary components.
A fixed salary is a predetermined salary that an employee receives regularly, typically once a month. The most salient feature of fixed salary is that it generally remains constant irrespective of performance, subject to employment terms and organisational policies.
An employee’s fixed salary is mentioned in his employment contract. In most jobs, it is the main component of an employee’s overall compensation package. The key components of fixed pay are an employee’s base salary, various allowances (house rent allowance or HRA + special allowance + transport allowance + medical allowance), provident fund (PF) contributions, and gratuity.
While fixed salary remains constant typically, employers can still change it for several reasons. For example, if there is an unexpected and severe downturn in business, changes to fixed salary are governed by employment contracts, labour laws, and organisational policies. Having learnt the fixed salary’s definition, let us discuss its advantages.
The main advantages of fixed pay are explained below:
Financial security for employees: When employees know that they will receive a certain amount as a fixed salary every month, they feel financially secure. Besides, they can plan their expenses and investments wisely with a fixed salary.
Budgeting: A company can budget for fixed salaries a lot better, as it knows in advance how much it is going to pay every month. Better budgeting also results in improved decision-making from a financial perspective.
Easier payroll administration: When an organisation pays fixed salaries, it does not have to keep on monitoring the output of its employees to calculate their salaries. That said, it still has to supervise its employees to ensure that they are working as per company policies.
Can discourage certain employees: If fixed salary forms a significant portion of overall compensation, it can discourage certain employees, who like to work overtime to earn more through variable pay. Hence, organisations must maintain a balance between fixed and variable salary.
May not adjust for inflation: Inflation can affect the real value of fixed income over time.. Hence, if fixed pay does not increase every year at least by the rate of inflation, employees may feel that they are not being suitably compensated.
Not linked to performance: At times, fixed pay is not tied to an employee’s performance, which can certainly discourage them from working hard. If they know that they will get paid the same pay regardless of their output, may reduce performance-linked incentives in some roles.
Variable pay, also known as performance-based pay, varies based on predetermined criteria. For example, a company can decide to provide variable pay to all those employees who meet their sales targets. A company can also pay a variable pay to its employees if it reaches a certain target.
Simply put, the criteria to pay a variable salary could be based on either an employee’s performance or a company’s overall performance.
By virtue of being variable, the variable pay component can vary a lot from month to month. Typically, variable pay forms a large part of overall compensation in performance-linked roles such as investment banking or sales., corporate sales, etc.
a) Can motivate employees to work hard: When employees know that they will get a significant sum as variable pay, they may encourage higher performance when linked to clear criteria in anticipation of variable pay.
b) Boost an organisation’s output: A company can boost its output by linking its employees’ performance with their salaries through a variable pay component.
c) Helps retain employees: Variable pay can support employee retention when structured transparently. By paying such employees a sizeable portion of their compensation in a variable component, a company makes them feel valued, which helps to retain them.
a) May cause infighting among employees: The component of variable pay can vary considerably from one employee to another. Hence, if employees get to know the differential between their variable pay, it may cause infighting, which may affect team morale if not communicated clearly.
b) May make the pay structure opaque: At times, companies structure the overall package of employees in such a way that it is difficult for them to understand the criteria for their variable pay. As a result, they are not sure how much variable pay they will earn, which results in dissatisfaction.
Having learnt the meaning of fixed and variable salary in detail, let us discuss fixed vs. variable salary. In other words, what are the main differences between fixed and variable salary?
The main differences between fixed and variable salary are explained below:
Criteria | Fixed Pay | Variable Pay |
Objective | The objective of fixed pay is to provide peace of mind to employees by letting them know that they will get a fixed compensation every month. | The objective of variable pay is to motivate employees by telling them that they can earn more by producing higher output. |
Consistency | Fixed pay remains the same month after month. | The amount of variable pay can change significantly from one month to another. |
Ease of administration | It is easier for a company to administer its fixed salaries. As the amount remains constant, an organisation can also budget for it easily. | Compared to fixed salary, variable pay is difficult to manage because its amount can vary significantly from one month to another. It is also difficult to predict, making it tough to budget as well. |
This comparison outlines the key distinctions between fixed and variable salary components of fixed and variable salary. You must also be having a grip over fixed vs. variable salary, which will let you understand your pay structure well.
Once you know how much money you will make, you can decide how much you intend to save. Most importantly, you should know the basic difference between fixed and variable salary. As discussed, fixed pay remains constant month after month. However, the amount of variable pay changes based on criteria, like an organisation’s performance or an employee’s output.
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The component of an employee’s salary that remains fixed from month to month is called fixed pay. The main difference between fixed and variable salary is that while the former remains fixed from month to month, the latter can change significantly.
Fixed pay is usually the sum of an employee’s base salary, allowances (HRA + special allowance + transport allowance + medical allowance), PF contributions, and gratuity.
As the amount of salary remains constant, fixed pay makes employees feel financially secure. Fixed pay is also much easier to budget than variable pay because companies can easily predict how much fixed pay they will pay over a year.
When employees know that they can earn a sizeable part of their compensation in the form of variable pay, they feel motivated to work harder. That said, they can also get stressed if their extra efforts do not result in better productivity. This is because variable pay is linked to an employee’s productivity and not to the number of hours he is putting in.
Variable pay is common in profiles related to sales, business development, investment banking, technology, retail & corporate banking, and customer-facing roles.
Employees need to research their industry well to understand how much fixed and variable pay they can demand. When it comes to variable pay, they need to be clear about the criteria based on which variable compensation will be paid. Overall, they should understand the value they bring to the table and they must negotiate based on that.
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