Severance Pay

Updated on January 4, 2024

Severance Pay Meaning

Severance pay is that pay that is paid to employees who are removed or terminated from the employment of the company. It is generally paid to the employees who are being let go from the job due to job elimination or downsizing, rather than the reasons for voluntary termination of job on the part of the employees.

Explanation

Severance-Pay

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Severance Pay (wallstreetmojo.com)

Why Are Companies Providing?

Severance is a kind of courtesy to the employees as it helps the employees much required time to find a new job with the least salary paid without being on the job. That is, the employees who are terminated not because of low performance but because of budget cuts or laying off, providing them with this pay helps them find a new job with an advanced salary. It is also related to the goodwill of the company unless the employer is obligated to pay the employees by way of the employment agreement or elsewhere in the employers’ rules.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Example

Let us say the Apple Inc. of the USA has a policy of paying their employees with the Severance pay when they are being laid off or their job is terminated due to a reason other than performance or misconduct.

The management decides the pay based on the salary of the employee being terminated, and the management also decides the no. of days to help employees cope with the financial help for a short period they would be unemployed and get time to find a new job or an alternate source of finance.

Severance Pay vs. Termination Pay

Severance pay and termination pay are different but generally termed as the same in the practical industry. But there are two different kinds of remunerationsRemunerationsRemuneration refers to overall monetary and non-monetary compensation that employees or independent contractors receive for providing services to an organization or company.read more to be paid to employees. Some of the key differences are explained below:

  1. Severance pay is not mandatory for any employer, whereas termination pay is mandatory to be paid on termination. There is no designated formula to calculate this pay. Also, it is at the employer’s discretion whether or not to pay and how much to pay. In contrast, Termination pay is calculated based on the no. of days notice a period employee has served before leaving the job, and it is mandatory to pay the employer.
  2. Severance is not the right of the employees as there is no backing of such payment unless it is in the employment contract or agreement. In contrast, termination pay is the right of the employees if the employee has completed his notice period before leaving the job.
  3. Both severance pay and termination pay help employees financially, but receiving severance pay from the employer will help to build the goodwill of the company as this is one kind of extra benefit the company would offer to its employees over and above the termination pay.
  4. Severance pay gives employees a little extra time to find another job or alternate source of income. In contrast, termination pay is that pay for which the employee has already worked for the employer.

Importance

  • Today in this competitive market, it plays an important role in creating goodwill of the company, which pays their employees the severance pay on their termination of the job from the organization due to various reasons, including layoffs, removal from the post, personal or various other reasons.
  • The employers don’t need to pay for it. Still, if it is mentioned in the employee contractual agreement, it becomes mandatory for the employer to pay the employee on leaving the employment.
  • The importance is also on the part of the employees. They might be susceptible to a shortage of funds when they are let go of the job. Hence, this severance can help these employees in terms of finance until they get a new job or until they get a new source of income.

Advantages

Some of the advantages are as follows:

  • Severance pay helps the organization in building its goodwill in the industry.
  • It helps employers get better employees as extra pay will motivate employees to join the company.
  • It is an added compensation for the employees, which helps them financially after being terminated.
  • Severance pay is paid at the discretion of the management. Therefore it is up to the management to pay or not the employees.
  • It helps employees get time to find a new job or alternate source of income with extra pay in their pockets, even for a short period.
  • It plays a role in the benefit of both the employer and employees.

Disadvantages

Some of the disadvantages are as follows:

  • Severance is not mandatory, due to which the employees may suffer financial losses when they are being terminated.
  • There is no rule or any law which backs this pay to be mandatorily paid by the companies.
  • If the company goes with the payment of such payments, then it would increase the employee’s cost to the company.

Conclusion

Severance pay is pay to help employees financially for a short period after they are terminated due to budget cuts, removal from the posts, or laying off, rather than the reasons for low performance or misconduct. It is a kind gesture from the employer towards its employees to help them financially and emotionally. Paying severance is for the organization’s benefit and helps build a reputation and goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more in the industry.

Recommended Articles

This article has been a guide to severance pay and its meaning. Here we discuss the importance, example, and why companies are providing severance pay along with advantages and disadvantages. You may learn more about financing from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *