A business has two basic ways of compensating an employee, and understanding the difference can help it save on the bottom line. A company can analyze what benefits it can purchase more cheaply than the employee can buy them. If the company provides those benefits, it can profit from the spread between the two costs.
Direct Salaries and Wages
Direct salaries and wages are the monetary compensation that employers pay their workers. An employee receives this pay for helping the company generate revenue. Examples of direct pay include base salary, bonus pay and overtime wages. These forms of compensation reward an employee for the quantity or quality of service provided to the firm.
Indirect Salaries and Wages
Indirect salaries and wages are the second form of compensation from an employer to an employee. They do not directly benefit the firm and are not paid to an employee for services provided. Examples of indirect salaries include paid time off, training, health insurance and retirement contributions. These benefits are all forms of compensation, but they are nonmonetary. The company is not paying the employee in actual dollars.
Direct and indirect salaries and wages have two major differences. First, direct salaries are actual compensation for services performed, while indirect salaries are a benefit of being employed. Second, direct salaries have monetary value, while indirect ones have nonmonetary value. The employee's goal is to have the largest total compensation package possible, while the employer's goal is to pay as little in total compensation as possible.
Advantage of Indirect Pay
From an employer's point of view, the advantage of indirect pay is that the employer may have access to a particular benefit at a cheaper rate than the employee. For example, the employer may get a quantity discount for providing health insurance to the whole company. In that case, the company will have to pay out less in total compensation because the value of the health insurance to the employee is more than the employer's cost. If the employer is a automobile company, it may make sense to provide the use of a car as a form of compensation. The employer can provide that benefit more cheaply than the employee can acquire it.
Alex Shadunsky has a bachelor's degree in finance and is pursuing a Master of Business Administration from Indiana University. He has worked at Briefing.com as a junior equity analyst specializing in health-care stocks.