How do I calculate sales commission for my salespeople?

A commission is a salesperson’s fee for helping make a sale. It can be the whole of their pay or be added on top of a base salary. And since a commission costs the business nothing when a sale does not happen, it makes pay a variable cost, which lowers the breakeven point. If you want to keep your breakeven point down, you will usually love the sales commission.

The math of figuring out how much commission to pay depends a lot on how your commission agreement is set up. Usually, it involves some set of these factors:

• The commission rate, which is either a percentage or a flat dollar amount. It is tied to some given amount of sales. You might offer someone, say, 6% of sales or $30 per sale.
• The commission basis. Usually that means the full sale amount. But it could also be based on the gross margin or net profit, which is what gets used when profit varies a lot from one product to another. Basing commissions on the margin pushes the sales staff toward selling the most profitable items. Basing it on cash collected mostly works to get sellers chasing overdue receivables. And a special commission rate for a product sometimes helps to clear out inventory that’s starting to go obsolete.
• Targeted rates. Once a salesperson hits a certain target, their rate may change. In some cases, it may even be retroactive, such as changing 2% of sales to 4% after the salesperson hits a quarterly sales goal.
• Shared commissions. There may be times when a second salesperson works on a sale. In those cases, the commission may be shared between them. Also, regional sales managers may take a cut of the commissions earned by their region.
• Commission payment timing. Sales commissions are usually paid on last month’s sales, usually because it can take time to get all the information needed to figure out commissions.

An Order for a Typical Commission Scheme

Working out commissions takes several steps that do not always happen in the same order. Here is an order for a typical commission scheme.

• First, set the commission period. This can be a week, month, quarter or another span that fits with your business. It often matches the regular payroll period for all your staff.
• Next, set the commission basis. This is usually either the price, the gross margin or the net profit of each item. Most often, there is just one basis type for all items sold. Also, sales returns in the period must be subtracted from the basis.
• Then do the math. Multiply the basis by the rate, which can be different for every product. Ten percent on a $1,000 sale means $100 in commission.
• Watch out for tiered rates. In some commission schemes, the rate shifts up with the sales volume. Say a business offers a 5% commission on all sales up to $50,000, and 7% after that.
• Split shared commissions. Work out how much of the total goes to each seller.
• Note any manager’s share. If a manager gets 5% of each commission, record it; $500 in commission has $25 set aside.

Should any commissions still be unpaid at the end of a pay period, you can record them in a reversing journal entry to reflect an estimate of the amount owed to salespeople and in payroll taxes on the commissions. This step will only be necessary if you use the accrual basis of accounting, and the idea is to record the cost in the period the sales occurred.

Consider how Mr. Smith’s quarterly commission worked out. He earned 4% of sales minus returned items. If he reached $60,000 in sales in a quarter, his rate rose to 5%, and the change was retroactive to the start. In the first quarter, he had $61,500 in sales and $500 in returns.

$61,000 in net sales, with a 5% commission rate, works out to $3,050.

Draw Against Commission

Can I use a draw against commission?

Yes, a draw is an advance paid to a salesperson that they work off through later earned commissions. If earned commissions end up higher than the draw, the employee gets the difference. If the earned commissions fall short of the draw, an employee may have to pay the rest back, depending on the agreement. A draw helps keep income stable and balanced in jobs that may have up-and-down swings.

A Cap on Commissions

Can I set a cap on commissions?

Yes, you can set a cap on commissions. This sets an upper limit on commission per customer, sale, territory or time period. After that, either no more commission is earned or the rate drops. Cap conditions should be clear. If they’re not, the practice will cause confusion, disputes and skewed incentives.