What is Commission Pay: The Complete Overview

Commission pay stands as a powerful tool that rewards employees for their contributions. But what exactly is commission pay, and how does it impact both employees and employers? 

In this guide, we dive into the basics of commission pay, exploring its various types, benefits, challenges, and practical considerations for implementation.

What is commission pay?

Commission pay is a form of compensation system where an employee receives compensation based on either a percentage or a predetermined sum tied to the sales they generate or the quantity of products or services sold. Commission pay is often an incentive for employees to perform better and boost sales performance. 

Besides sales, commission pay is also present in the following types of jobs:

• Recruiters
• Real estate brokers
• Account managers
• Travel agents

Types of commission pay

There are different types of commission pay that employers can implement to motivate and reward their employees. This section will cover them in greater detail. 

1. Straight commission

Straight commission is a pay model where an employee’s pay depends solely on their sales performance. There’s no fixed salary or hourly wage; instead, earnings are based upon the sales they secure.

Operating solely on commission can motivate individuals who are confident in their sales prowess and dedicated to reaching their targets. Yet, it also carries significant risk, with income prone to fluctuations influenced by market dynamics, competitive forces, and shifts in customer demand.

2. Salary plus commission

Combining salary with commission offers employees a balanced income stream, ensuring stability while also motivating them to drive sales and improve the company’s profitability. The fixed salary component ensures financial stability, while commissions open the door to limitless earning opportunities tied directly to their sales achievements.

This hybrid model, prevalent in sectors like sales, blends a guaranteed base salary with commissions determined by the value and frequency of deals closed. It appeals to individuals seeking an equilibrium between steady income and the potential for enhanced earnings.

3. Variable commission

Under the variable commission pay, the commission rate fluctuates in accordance with the sales generated. For instance, employees might receive a higher commission rate upon exceeding specific sales targets or reaching sales milestones. This approach motivates employees to strive for excellence.

Moreover, variable commission compensation serves as a strategic tool for companies to regulate expenses, as they can tailor the commission rate to align with their business needs and budget.

4. Draw against commission 

In a draw against commission pay, the company gives a predetermined sum, known as the “draw,” to the employee at the beginning of their employment. If the employee generates sales exceeding this amount, it constitutes their earnings, with any surplus being classified as commission. However, if sales fall short, the employee is obligated to return the entire draw to the employer.

While drawing against commission may appear risky due to the absence of a guarantee that sales will match the upfront amount provided, many employees view it as both a target and an incentive to drive sales.

5. Bonus commission

Companies offer bonus commissions to employees who have surpassed sales targets. These additional commissions aren’t guaranteed, and companies have no obligation to provide them regularly. Bonus commissions serve as an extra incentive for employees to maintain their sales momentum, even after reaching their commission objectives.

Advantages and disadvantages of commission pay

Whether you’re an employee considering a job with commission pay or you’re an employer offering a commission-based job, it’s important to consider the following aspects of commission pay. 

Advantages

• Increased motivation — With commission pay, employees feel more driven to hone their skills, cultivate stronger professional connections, and maximise their time in order to hit sales targets and increase their monthly commission earnings.
• More freedom — When a salary is based on sales performance, employees may find more agency in controlling their efforts. In certain industries, securing a handful of good deals could ensure a satisfactory annual income, allowing more free time. 
• Control of payroll expenses — By tying employee earnings directly to the sales or income they generate, employers can effectively minimise costs, particularly for underperforming employees. 

Disadvantages

• Income fluctuations — Commission-based pay can lead to irregular earnings, making it difficult for employees to predict their monthly income. This inconsistency may create financial stress and uncertainty, especially for those who rely on a stable income to cover regular expenses. 
• Burnout and job dissatisfaction — The stress of maintaining high-performance levels, combined with the fear of falling short of targets, can lead to burnout, fatigue, and, ultimately, job dissatisfaction. 
• Market conditions — Commission-based earnings are heavily influenced by market conditions and external factors beyond the control of employees. Economic downturns, changes in consumer behaviour, or shifts in industry trends can all impact sales performance and lead to revenue volatility.

Calculating commission: an overview

Accurate calculation of a commission requires a clear understanding of the terms outlined in the employment agreement. It’s important to take into account the following factors, as they play a significant role in determining payments:

1. Commission base — The commission base represents the figure upon which the calculation is based. Typically, it encompasses the total sales amount, though it could alternatively entail the gross margin, net profit, or inventory value.
2. Commission rate — This is the fixed figure or percentage linked to the sales amount.
3. Override — The commission rate might undergo changes based on the outcome.
4. Commission period — The duration during which you calculate the sales amount and apply a commission is known as the commission period.
5. Split —  If multiple individuals contribute to the sales, the commission may be divided among them. 
6. Commission tie —  A policy may implement one rate for a specific portion of the commission base and a different rate for the remainder.

Implementing commission pay in your business

If you’re thinking of implementing commission pay in your businesses, here are a few tips that will help you set the commission pay system in motion. 

1. Determine the type of commission pay

The initial stage in establishing a commission pay involves determining the compensation structure, which determines the proportion of an employee’s earnings allocated to base salary versus sales commissions. 

Employers might opt for a structure where 75% of compensation is allocated to base salary and the remaining 30% to commissions. Selecting the appropriate one mostly depends on the structure of the business. 

2. Set payment days

Once the compensation mix has been decided upon, the next step is to establish the payment dates for distributing sales commissions. There’s flexibility in how commissions are disbursed, but it’s important to strike a balance that is both financially viable for the company and fair for the employees. 

For instance, options include distributing commissions on regular paydays or consolidating them for payout either at the start or end of each month.

3. Set realistic target goals

The target goals for the employees should be both feasible and realistic. Employers can consider setting sales targets slightly higher than the typical sales quota, accounting for variations across departments and individual skill levels. 

It may be necessary to customise goals based on different employee groups, as some may achieve certain targets while others may not.

4. Use technology to streamline calculations

Employers can utilise specialised software or custom-built solutions to automate the entire commission calculation process. These automated calculations can minimise errors that may occur in manual calculations, ensuring that employees are paid accurately and promptly.

Moreover, technology helps employers save time and resources that would otherwise be spent on manual calculations and administrative tasks. This allows HR and finance teams to focus on more strategic initiatives and employee engagement efforts.

Tax implications of commission pay

Determining how much gets withheld from the employees’ commission pay is based on a few scenarios. If the extra income is included in the regular pay and it’s not broken down separately, it’s taxed just like a regular paycheck.

However, if the employer withholds taxes from the regular pay and the commission comes separately or is listed separately, there are two ways they can handle it:

I. Percentage method — The employer can just take a flat 25% of the commission pay for taxes.

II. Aggregate method — This method involves several steps for the employer:

1. They add up the employees’ regular pay and your commission.
2. They figure out the taxes on that total amount as if it’s one big paycheck based on the employees’ allowances from the W-4 form.
3. The tax amount for solely the regular wages is determined.
4. The tax withheld from the regular wages is subtracted.
5. Finally, the employer withholds the remaining tax from your commission.

Conclusion

By grasping the different aspects of commission pay and its associated considerations, both employers and employees can effectively use this compensation model to drive performance, enhance productivity, and foster mutual success in the workplace. Hopefully, this blog equipped you with enough information on the basis of commission pay.