We are in the process of reviewing our rules on commission payouts for our sales execs. Currently, we have quarterly goals and incentive structures for each rep/territory. We have not had a clear cut payout rule for commission on attainment of those goals, except for a general alignment to the idea that the $'s must come in before payout occurs. While we do have some customers with long receivables days, we have minimal uncollected receivables historically. I'd love to hear any thoughts or best practices on this from the group. Keeping things as simple as possible is important to us, but we definitely do not want to payout until we have assurance that the $'s are in. Our general thought is something like full payout when 50% or 75% is paid. Thanks in advance
Best Practices for Commission Payouts
Answers
We always payout after payments are received, consistent with the related cash flow from sales. Commissions always paid within 30 days (often sooner) of receipt for related sales. One rate (%) until quota is achieved by quarter (rolling during year) and then paid out at higher rate thereafter. When collections come in later quarters, commissions are paid out at whatever the rate was from the applicable booking quarter.
Consider also the issue of what you want your sales people to do. Close contracts or chase cash. You could make the chasing cash a bonus element of the AR department. The former gets paid on a pre-defined schedule, say 60 days out, which is hopefully in line with the average receivables
We calculate commissions with month end close and pay out in the following pay period. The commissions are paid only on the payments received in the period.
To a large extent I agree with the comment about considering what you want sales people to do. If you have a decent AR staff (in size or ability), you can shift the collection responsibility to them and allow sales to focus on what they do best. However, I've experienced this to lead some sales people to push bad contracts through, deliberately, to inflate their numbers, resulting in an expensive waste of time on all other departments when it came to implementation and collection, and ultimately losing the customer.
We pay commissions 30 days after the month closes, however we do not require the payment to be collected prior to the commission being paid. We don't do contract work, its all direct or distributor sales, so if a sale does go bad, we deduct it from future commissions. The sales person is responsible for selling, not collections. The chance of a bad contract/sale can be reduced through credit checks and adequate research on the purchasing company. Investing in your Receivables/Collection department is usually money well spent.
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We are a manufacturer and we do everything you describe above except for commissions are paid 60 days after the month closes. Have not had any issues in 10+ years. We also have a Sales Rep Agreement similar to the "Rules of Engagement" Bob S. references in a below post.
Whoever does the collecting it is a preferable practice to pay commissions on paid business. Keeps sales aligned with the true goal of putting cash in the company's coffers and reduces the
The simplest method I have used was to pay based on the previous month's Company DSO. If a customer balance was written off, the sales rep's commission was adjusted accordingly.
If you are going to pay on any $ not yet received, be sure you have a claw back clause in your commission agreement that is legal in your state.
We formalize everything in a "Rules of Engagement" document. In this way, we minimize disputes. Included in our Rules of Engagement is what defines an eligible sale, territories, sales categories, side agreement policy, timing of commission payments, cancellation policy, errors policy, split credit policy, transfer/promotion policy, and termination policy. Rep must sign an agreement acknowledging these rules.
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Bob
I like the approach you outline at your company. I think it is also key to determine the philosophy that should stand behind sales commissions lans and how this compares with other variable income paid elsewhere in the organization. The culture and values of the company can be manifest in the way this often visible and volatile topic is managed by the execs.
For example:
1. What behavior do you want to encourage? If a mid level rep lands a huge deal that would make him the highest paid person in the company that quarter/year, is the CEO going to accept that, or find a way to limit the payout for capricious reasons?
2. If the sales team relies regularly on colleagues to design winning proposals and/or solutions (esp. in engineering/custom product/services), do the sales support folk also share in the bonus?
Regards
Len
Sales people have their own mentality and when they close a deal they want to see that reward, sometimes a big reward. If you want them to be effective, cater to that reward. I only advocate this in clean deals i.e. no contingencies.
But, have a policy to recoup the commission after 90 days if payment is not made for ANY reason. Don't get into whose fault it is that you are not paid. You will lose that argument with a sales guy.
State all this in a written policy and keep it simple. Have them sign the policy in order to get paid.
A very effective
Great comments.
Be careful to not get into a culture where the sales person is shying away from the potential slow paying client. Many of our slower paying clients are some of the most loyal we have.
A couple of thoughts, first I concur with paying in the month following collection. Secondly, I would pay based on margin not for the gross amount of the sale especially if the sales person has authority to set the price and negotiate the margin.
We first make certain that the commission is based on gross profit, not gross revenue. Next, the commission-able gross profit must cover base pay, benefits and travel expenses. Last, all revenues must be collected in order to receive commission. If uncollected, then it is added to the next commission payment only if the cash was received in 90 days max. Any receipts beyond 90 days are no longer commission-able.
I think that it is important to identify the real purpose of your commission plan; or any variable compensation plan. Generally, that purpose is to motivate performance and reward success. Because our objective is to motivate our sales reps to go out and generate business; we want their payout to be as closely aligned as possible to their success in closing deals.
Our commissions are calculated based on gross profit on a monthly basis and paid at the end of the following month; whether collected or not. Because we have a strong credit function and aggressively pursue our collections, we have generally collected our receivables by the time our commissions are paid. However, we do not want to tie our sales compensation to any inefficiencies we may have in collecting our AR.
While I understand the points about linking cash flow to the timing of commission payouts; I don't want our sales reps to be demotivated by having to wait for their compensation because of some issue that may be out of their control. Once our credit process has approved the sale; then the sales rep has met their responsibility and we want them to move on to the next opportunity.
In my experience, at various firms, we had the best success when we paid based on cash receipts, not order placement - but we often counted quota achievement on orders received. In particular, this helps balance things out for commission payments: the new deals that miss b/c cash not yet received are offset by old deals where the cash finally gets received. At the same time, they get recognition for the "heavy lifting" of getting the order by measuring quota on orders. Actual commission payments don't change until cash receipts exceed quota, but your monthly / quarterly quota attainment reporting is tied to what they DID in the time period you're reporting on. This balances the incentive for the sales team to sign up paying customers, yet keeps them focused on future sales without losing interest in having paying customers.
Where Finance can best help is in having a good deal review & order placement process: make sure prior to the order ships that there's a clear record of who on the client side has to approve the invoice, what support they will need so they can approve it, the steps in the process, what actions trigger payment, etc. In this way, the organization knows in advance what has to get done, and your A/R and collections team can make sure the right steps are completed in the right order, AND that they know the right person to contact at the customer to facilitate getting the payment through. Having sales involved in getting that data before the order is placed keeps them "in the game" which is critical since they have the relationship with the customer (and your collections team doesn't have to start from scratch to build that relationship).
But the biggest issue is that relieving the sales team of those "administrative" follow-through details and instead focusing your
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Based on your scenario, is there a penalty/reduction to commissions for any A/R amounts that remains unpaid after a certain number of days?
Again assuming they finally do get paid.
You want to check the law in each state. Some will not allow you to hold back compensation until the receivables are collected depending on how the job is structure for the employee. A company I worked for got burned big time in court.
Many of our clients process sales commissions using the cash received basis when payed in full. However, it depends on your industry as well as some industries like insurance companies have less credit risk. For example, an insurance agent signs up a client with an insurance carrier. The carrier gets paid by the end-client so in those cases, the insurance agent gets paid when the client is signed up and not when the carrier gets paid.
The other day, a rep told me that an insurance carrier had decided to pay commissions daily since most of their agents are 1099. Sign up a new client today, get paid tomorrow. Better have a great sales commission
Also be aware that in some states like California, companies are required to provides a sales rep with an agreement on how commissions are to be calculated. There are many good sales commission agreement templates available to help document this requirement.