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Importance of Clear Definitions in a Sales Compensation Commission Plan

written by: •edited by: Linda Richter•updated: 10/13/2011

If you pay your employees on commission, it’s important that you set clear definitions in a sales compensation commission plan. You must have guidelines and rules and understand the difference between draws and actual commission paid, as well as tax deductions.

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    What Is a Sales Commission Plan?

    Dollar US Wikimedia Commons There are two types of sales commission plans: One is a commission-only based plan and the other is a combination of salary plus commissions.

    With a commission-only plan, salespeople are paid a percentage from the products they sell. In a salary-commission plan, the salesperson receives a normal set salary and receives commission payments on top of that salary.

    Because commission plans can be complicated, it’s best to have clear definitions in your sales compensation plan to avoid confusion.

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    Setting Up a Commission Plan

    Your sales commission plan should be based on the type of business you are in. You also need to determine, if your plan is commission-based only, what percentage you want to offer your salespeople. For example, in the auto industry, it’s standard to pay salespeople a 25% commission off the gross sales, minus what is called dealer pack. Finally, will the percentage paid be based on the gross or net profit of each sale?

    Some companies opt to pay a commission on the net profit of each sale. In this instance all the costs or expenses are deducted from the gross profit and then a percentage is paid on the net profit. This type of sales commission plan is usually not well received as the salesperson could make the argument the costs or expenses deducted from a sale should go to departmental overhead.

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    Make It Clear

    G is for Goals Wikimedia Commons Cover the following elements in your commission plan:

    • Type – Define the type of commission that will be paid and how it will be paid. Find what the average percentage is that a salesperson should make in your industry.
    • Draws – Most sales plans offer the opportunity for salespeople to take a draw against their commission if they haven’t sold anything or are under their monthly goals. Companies pay a draw at the 5th of each month and actual commissions on the 20th of the month minus the prior draw received. Income taxes such as Social Security, Medicare, plus federal and state taxes are usually not taxed at draw times but at actual paid commission dates. For example, if you gave a salesperson a $1,000 draw and the actual commission made for the month totaled $2,000, the original $1,000 draw would be taxed at actual paid commission time and then deleted so the salesperson would actually receive $1,000, less appropriate taxes.
    • Bonuses – Your team needs to be motivated to sell. More and more these days, many sales companies are offering flat rates on any type of sale and skipping the bonuses. Why would anyone be motivated without the hope of a bonus or contest to reach a bonus? Mix up what you offer for bonus goals. Clear definitions in a sales compensation commission plan should clearly define if they sell A, B, & C, they will get a bonus, and the bonus amount should be revealed prior to goal setting. Bonuses can also come with the sale of old inventory you want to get rid of. Offer any salesperson that rids you of old inventory a higher percentage or flat rate bonus on selling the item. Bonuses can include paid time off, weekend getaways, or dinner coupons.
    • Group Efforts – Another goal/bonus type you may consider is that if the entire sales group meets quotas, they all get a bonus. Decide on a group bonus amount before including it in the plan.
    • Review the Plan – Your sales commission plan should be reviewed often to ensure your goals are still realistic. While upper management doesn’t like to do this, they should involve the sales team when writing the sales commission plan. This gives salespeople the opportunity to ask questions, offer suggestions, and be clear on how the plan will work. You also need to review your plan to ensure the goals you have set are even reachable in your market. If they’re not, you don’t have a fair sales commission plan.
    • Overseeing the Plan – Once the plan is in place, you need to determine someone to enforce the plan. Expect confrontation about low payouts from salespeople and have a knowledgeable person answer questions and oversee the plan. Consider using a manager and a payroll or Human Resources person to oversee the plan. With two people, often getting the salesperson to understand how he or she was paid is better than only utilizing one authority figure.
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    What About Legalities?

    Judges Gavel Paying draws and commissions can be tough if you don’t understand the legalities behind your plan. An important part of clear definitions in a sales compensation commission plan means you need to explain what happens if a salesperson sells nothing or has collected too many draws with no sales.

    Most states, as far as paying employees, are governed by each State’s Labor Laws. Often these laws are set by the US Department of Labor but can vary from state to state.

    For example, if you have a salesperson on-site all the time, if he doesn't sell anything, and has been paid too many draws and then payroll comes along, you can’t just skip paying him. In New Mexico, even if an on-site salesperson doesn’t sell, the employer is still required to pay the salesperson minimum wage based on the amount of time spent at the store.

    For salespeople that are paid through territorial commission sales, or those who are based away from the store, you may not have to pay the salesperson minimum wage as it may be impossible for you to account for hours actually worked.

    Prior to setting up your sales commission plan, it’s best to check with your local Department of Labor to ensure you are following labor laws on employee payouts.

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    Get Some Guidance

    When paying employees on commission, if you’ve never done it before, try and obtain some guidance from like-businesses. When we first began our lives in the franchise auto industry, my husband and I contacted other dealership owners to see how they paid their sales employees.

    One great sales commission plan book available from Amazon is The Complete Guide to Sales Force Incentive Compensation: How to Design and Implement Plans That Work by authors Zoltners, Sinha, and Lorimer. This book is all-inclusive for any type of industry where sales commission comes into play.

    If you set clear definitions in a sales compensation commission plan, obtain some guidance, and review the plan from time to time, you’ll not only have happy salespeople, but salespeople that are motivated.

Sales Commissions and Pay Plan Rules and Tips

Looking for information on sales commission plans or want to know the legalities of a sales compensation commission plan? This series offers up all you need to know including how to calculate sales commissions in Excel.
  1. Paying Employees on Commission
  2. Importance of Clear Definitions in a Sales Compensation Commission Plan
  3. Need a Template for a Sales Commission Plan?
  4. Proven Sales Techniques for Exhibitions & Trade Shows
  5. Top 10 Cold Calling Sales Techniques