The annual raise is a thing of the past, says a recent report. Seventy-eight percent of companies polled by the Institute of Corporate Productivity admit that they are only handing out raises based on job performance. In fact, 54 percent are withholding raises to lower performers altogether.

"Managers are looking for their top performers and who they want to keep, as well as how to retain them, how to better utilize them, and how to compensate them for their performance," says Jay Jamrog, senior vice president of research for the Institute for Corporate Productivity. "Properly identifying and recognizing your best employees is crucial during tough economic times like these."

Doing so is not easy, however, as there are numerous ways to valuate success. Only 21 percent tie performance ratings to fixed standards such as sales, outputs, or speed. Just 17 percent compare workers with each other to create a competitive scale, whereas 46 percent use a variety of alternative methods including rating performance goals on a scale of one through five.

So what should a small business owner focus on when evaluating their employees? According to Jamrog, the most critical factor is training managers to be fair and accurate when accessing goals and standards and assigning values on the scale. Furthermore, Jamrog stresses the importance of adequately addressing low-performance employees.

"A lot of managers end up placing most of their employees at the top of the scale, in part to avoid negative confrontation, and that defeats the purpose," he says. "Managers need to be able to sit down with an employee and have not just the good conversations, like, "you're going to get a 10 percent bonus," but the bad ones too, like "you're not getting a 10 percent bonus, and here's why."