The 5 Critical Steps to Create the Bulletproof Merit Budget 2016

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Merit Pay delivers different rewards for different employees.
Merit Pay delivers different rewards for different employees.

Few compensation communications will have more impact on your organization, and   be questioned pointedly and relentlessly, than your presentation of a merit budget.

Top executives, finance professionals and managers will all quiz you on how you derived the number and how it supports the company’s compensation strategy. With 2016 around the corner, it’s a good time to review and bulletproof your merit budget.

Here is some guidance on all the ins and outs of a merit budget, to help you both develop and defend your calculations. 


Typically, the merit budget is a tiny subset of the salary budget. It represents planned growth in average salaries for the people you have on board at one snapshot in time.


A merit budget is different from the Finance department’s expected salary expense budget. It is not the cost of the actual salary expense increase, but rather an estimate of the growth in your current average salary.

1. What Should You Look At First?

Your organization’s position to market should be a key factor in creating a merit budget. Knowing what market data to consider means you must understand your company’s compensation philosophy.

Ensure that you know the answers to these questions:

• Do we age market data to the beginning, end or middle (lead/lag) of the planning year?
• Are we shooting for the average, 50th percentile or some other percentile of market?
• Have we compared to the right market rates, especially in international locations (e.g., base salary, guaranteed pay, total cash, etc.)?

Definition: Position to Market

A term used throughout the compensation community. Unfortunately, many don’t understand what that means. If you’re a mathematician, you’ll assume that position to market means the difference between your salaries and those in the market, divided by the market as in this formula:

Your Salaries – Market Salaries/Market Salaries

In HR though, you should use your salaries in the denominator because your merit budget will be a percentage of YOUR salaries.

Your Salaries – Market Salaries/Your Salaries

2. Measuring Your Organization’s Financial Strength

Like a gate objective in your incentive plan, your organization’s financial strength will determine or modify your merit budget.

(After all, it doesn’t matter that you’re five percent below the market if you can’t afford a five percent merit budget!)

But can you afford it even if your company is suffering financial problems?

Maybe. You really need to know how many layoffs and new hires, if any, are planned, to fully understand..

·        It could be that the merit budget is such a small part of the overall salary expense budget that you can be more generous than you think.

·        Also consider that your employee population is going to be jittery during these times and may need the encouragement brought with a healthy merit budget.

3. Promotions and Adjustments…Do They Matter?

You may be asked to carve out a portion of your budget for promotions and adjustments. Regardless of whether these factors are in or out, you still need to know how they affect your budgeting.

Look at your organization’s history in this regard.

·        What percentage of people got promotions and adjustments in the past few years?

·        Did managers stay within guidelines in giving them?

What is Everyone Else Planning?

Find out what other companies are doing through the myriad of surveys on the topic. World at Work and many others provide their survey results on this subject in late summer.

4. Coming Up with the Final Budget

Based on the factors discussed above, decide on an overall merit budget for your organization.

Be sure that you’ve considered special groups and locations that require larger or smaller budgets, particularly if you have international locations.

See our Compensation Case Study below for some right and wrong examples of merit budget formulas.


5. Getting final approval

Before offering the final numbers, prepare yourself to present information covering the company’s past trends, what you know about your competitors’ merit budget projections for next year and your organization’s position to market.

Compensation Pros Tip

Senior management wants you to make the decision easy for them, so show them how the merit budget you’re projecting will actually affect the organization’s bottom line, for both the upcoming fiscal year and the one after that.

This thorough review will show management and the finance group that you considered the nuances, and evaluated the critical factors.



If you consider only position to market and competitor merit budgets, how would you calculate your merit budget?

Your Position to Market: -2.5% (below market)
Projected Competitor Merit Budgets: 3.0%

What is your Merit Budget:

A. 5.5%


B. 5.575%


C. .475%


D. 3.25%



 (b) 5.575% 

You increase your current salaries by 2.5% to match market, then another 3.0% to ensure that you meet market after your competitors have completed their increases.

Calculation: ((1.00 X 1.025) X 1.03) =1.05575 or 5.575%.