Knowing how to calculate sales commission influences the thoughts of salespeople every day. It's where "the rubber meets the road," where all their skill and commitment get converted into rewards. Calculating sales commission matters to sales managers too. They need a commission structure that rewards effort and success and leads to a happy and motivated salesforce that delivers results. In this blog, we'll go through how commission works and how best to calculate it, using the various factors that influence it.
Before diving into the details, let's look at the basics.
What is Sales Commission?
Sales commission is how most professional salespeople get rewarded for their effort and results. Managers use sales commission to motivate their sales teams to focus on the business's success. Sales commission can be simple or complex. It depends on whether a product has a straightforward or multifaceted sales process, the length of the sales cycle, and a product’s route to market.
Understanding how to calculate sales commission accurately matters to everyone. Salespeople want to know the rules they need to follow to earn their rewards. They don't want to waste time focusing on business that won’t attract sales commission. They also need confidence that their sales commission will be paid quickly, without needing to argue over every line item. If they can understand how much they'll earn on a deal before it’s closed, then that's even better.
Managers want to know that the commission program is working well and getting the results they want. And they want to understand how it can be improved to deliver even better outcomes.
Factors that Influence Commission Payments
A sales commission plan can be simple or complex depending on the sales process and how a product is sold to an end-user. Here’s a comprehensive list of factors you can use to design the perfect commission scheme for your business. You can then use it as a basis to calculate sales commission.
The commission basis defines what sales revenue will have commission paid on it and what won't. Depending on the plan, not all revenue attracts a sales commission. Some products need support and maintenance after they’re purchased. Some companies don’t pay commission on this type of revenue. Sales territories matter too. Account managers don’t get paid on a deal outside their territory, but there are circumstances where they need to be, for many reasons, but at management’s discretion.
The commission rate is the percentage of a transaction paid to a salesperson when they close a deal. The percentage may be fixed or variable. It might even be a defined monetary value per product sold. Whatever the arrangement, a salesperson needs to know what their likely sales commission is before closing a deal.
Commission overrides are extra rewards for extra effort. These kick in when an account manager has achieved a certain quota level, generally above 75 percent. Overrides incentivize successful salespeople to push for over-achievement.
Commission splits reward multiple salespeople for a deal. A deal may need several salespeople to help close it, for example, where a partner has helped the customer select your product. The customer account manager and the partner account manager may share the commission using a split. The arrangements of the split will vary per deal.
The commission period is the length of time – a month, a quarter, or a year – where a sales commission rate applies. A commission rate can vary depending on the period. A Q1 deal can have a better commission rate than a deal in Q4 because businesses value money in the bank earlier in the year rather than later.
Types of Sales Commissions
Commission bases, overrides, splits, and periods are the building blocks of your sales commission structure.
Now let's look at the types of sales commissions that will define how much a salesperson will earn on a deal. You need to understand these fully to calculate sales commission.
The straight commission model is commission-only sales. There’s no base salary; a salesperson only receives a percentage of the revenue they close.
Graduated commission pays higher sales commission rates at higher quota achievement rates. It rewards higher achievement and overachievement to help "success breed success."
Revenue commission pays a percentage of the overall sales revenue to a salesperson, let's say 10 percent. This model can apply to straight commission and base salary + commission models.
Gross Profit Commission
Gross profit commission is sales commission paid on the profit margin of a deal rather than the revenue. For example, if there are several components to a deal, like products and implementation services, where each has different profit margins.
How to Calculate Sales Commission
Knowing how to calculate sales commission matters. Be accurate, transparent, and efficient. Follow these straightforward steps to calculate sales commission, every time, accurately.
Determine the Commission Period
Firstly, confirm the commission period for transactions. Commission rates can change every month or quarter.
Calculate the Commission Base
Next, confirm how much revenue in a deal will pay sales commission under the plan. Maintenance revenue may not be eligible, and some special contract terms, like co-term payments, may not be either. With that confirmed, check what the base commission rate is for the different components in a deal. High-margin product revenue will likely pay one rate, and lower margin services a lower rate.
Calculate the Payable Commission
To calculate the payable commission, multiply the sales revenue by the sales commission rate. A 10 percent commission rate on a $10,000 product deal would pay $1,000 in commission.
Apply Any Commission Variables
Once you have the payable commission, you can apply commission variables for which a salesperson is eligible. A new customer deal might get a 20 percent uplift, as well as a standard commission. In our example, this takes the 10 percent rate to 12 percent, paying an extra $200.
Apply Tiered Commission Rates
If a plan uses tiered commission rates, then apply them here. In our example, the $10,000 deal closed in Q1 gets a 10 percent uplift, taking the 10 percent commission to 11 percent. If it closes in Q4, it will likely get no uplift, and the commission rate would remain at 10 percent.
Calculate Any Overrides
Overrides aim to reward high achievement. In our example, the 10 percent commission could be worth 12 percent if a salesperson hits 75 percent of their quota in the year.
Commission typically gets paid on contract signing. If, after 90 days, the customer still hasn’t paid, for whatever reason, it's normal to claw back any commission paid through commission payments on other deals. Deduct these at the end.
If a deal involves more than one salesperson, you can split the final commission as the company sees fit.
Remember this: the combination and sequence of these incentives matter when calculating sales commission. Be transparent with everyone about how all these factors work together to manage everyone's expectations better.
Streamlined Sales Commission in Action
Knowing how to calculate sales commission quickly, efficiently, and accurately is essential for all organizations that employ sales professionals. Salespeople are more motivated and productive when they know their goals and are confident about how they are paid for achieving them. Managers are most effective – and happy – when they see the commission process is working smoothly, is accurate, error-free, and easy to manage.
Varicent delivers these capabilities with its powerful and proven Incentive Compensation Management (ICM) solution that’s quick to deploy and easy to use. Book your demo now.