Calculating commissions is essential to motivating and rewarding sales representatives for their performance. The process can be complex, involving several steps such as setting a commission period, calculating base pay, applying commission variables, and deducting returns.
Whether you're a sales manager or a sales rep, understanding the commission calculation process can help you achieve your sales goals and maximize your earnings.
However, calculating commissions can be a tricky task.
Why is that?
Commission calculations consist of many variables like commission rate, overrides, returns, and commission splits.
In this blog, let’s look at how to calculate commission in nine essential steps, along with examples.
Let's get started!
How to Calculate Commission
Commission calculation depends on the commission structure, the industry, the specific terms of the agreement, and more.
However, the basic formula for calculating commissions is:
Commission = (Sales Total x Commission Rate)
So, if a salesperson makes $10,000 in sales and their commission rate is 5%, their commission would be as follows:
Commission = ($10,000 x 0.05) = $500
Additionally, companies also use more complex commission structures like a tiered commission or different commission rates for different products or services.
To calculate such commissions accurately, it’s critical to understand the specific commission structure and terms of any commission agreement.
Now, let’s take a look at nine essential steps for calculating commission sales commission:
1. Set the commission period
The commission period is the time frame between which the sales performance is measured.
Usually, the employer determines the length of the commission period, which might be anything from daily to quarterly or even annual.
While setting the length of the commission period, it’s important to keep the company's sales cycle and transaction time in mind.
Additionally, you should consider the timing of company events like fiscal quarters or product releases, which may affect sales performance and the computation of commissions.
2. Calculate the base pay
Sales reps also receive what is known as "base pay," which might be a fixed salary or an hourly rate.
Multiplying the representative's hourly rate or annual salary by the number of hours or days worked during the commission period will give you the base compensation.
A sales representative’s annual compensation is $60,000 and they’ve worked 160 hours/month.
So, their monthly compensation would be: $60,000/12 = $5,000/month
3. Calculate the payable commission
The amount of commission that the representative is entitled to receive as a result of their successful sales performance throughout the commission period is referred to as the payable commission.
To determine the amount of commission, multiply the representative's commission rate by the total sales made during the commission period.
A salesperson produces $100,000 in monthly sales and receives a 10% commission.
Due commission = total sales made x commission rate
Due commission = $100,000 x 10%
Due commission = $10,000
The commission calculation would be more complicated if the representative's commission rate for sales of a certain product was 15% and $50,000 of their sales were for that product:
Total Commission = ($50,000 x 15%) + ($50,000 x 10%)
= $7,500 + $7,500
= $15,000
4. Apply any commission variables
Commission variables are the extra amount that a sales representative receives upon achieving a set target. It can help motivate your sales team to concentrate on particular items or sales goals.
A sales rep will receive a 10% standard commission on a total sale of $50,000. And if they make more than $60,000, they’ll receive a 25% uplift on the standard commission.
So, if the sales rep made $62,000 in that commission period. They set to earn:
Payable commission = $62,000 x [10%+(25%x10)]
Payable commission = $62,000 x [10+2.5]%
Payable commission = $7750
5. Apply any commission variables
Commission variables are the extra amount that a sales representative receives upon achieving a set target. It can help motivate your sales team to concentrate on particular items or sales goals.
Here’s an example of a tiered commission structure of sales rep A:
* 5% commission rate for sales up to $10,000
* 7.5% commission rate for sales between $10,001 and $20,000
* 10% commission rate for sales over $20,000
Now, if total sales for the month were $15,000, the tiered commission is calculated as:
Total commission = (5% x $10,000) + (7.5% x $5,000)
Total commission = $500 + $375
Total commission = $875
Read our article on tiered commission structure.
6. Calculate any overrides
Overrides are additional commissions that are given to a manager or supervisor based on the performance of the sales team that they are responsible for.
The amount of an override is often computed as a percentage of the team's overall commission or sales.
Overrides can be a great motivator for managers to coach and encourage their team members to reach higher levels of sales performance. This is because this amount is typically paid out at the end of the month.
Let's say your sales team made 10% more than their monthly sales goal. Because of this, you've decided to give your sales manager a 2% raise.
So, if your sales team made a total of $100,000 in one month, then:
Override = Total Sales x Override Rate
Override = $100,000 x 2%
Override = $2,000
You would then add the override amount to the manager's base pay to determine their total commission payout for the month.
7. Deduct returns
Returns or commission clawbacks are defined as sales that are subsequently canceled or reimbursed, and they’re a factor that can influence how commissions are calculated.
To determine the commission owed, take into account any returns by deducting the amount of any returns from the total sales the rep has made.
Let's say a salesperson sold a product for $1,000, but the customer sent it back and got a $500 refund.
Here's how to figure out the commission:
Payable Commission = (Total Sale - Returns) x Commission Rate
Payable Commission = ($1,000 - $500) x 5%
Payable Commission = $25
Read our article on commission clawback and how to craft a fair return policy for your people.
8. Split commissions
A split commission, or shared commission, is a commission that is shared amongst numerous sales representatives for a single sale.
To calculate split commissions, determine the percentage of the sale that each representative contributed, then apply the commission rate that corresponds with that percentage to each representative to calculate split commissions.
Let's say that two salespeople are sharing a commission for a sale they both helped make. The lead was found by sales representative A, and sales representative B closed the deal.
The whole sale was for $2,000, and the rate of commission is 5%. Here's how to figure out how much each person gets:
Sales Rep. A:
Payable Commission = Total Sale x Contribution Percentage x Commission Rate
Payable Commission = ($2,000 x 50%) x 5%
Payable Commission = $50
Sales Rep. B:
Payable Commission = Total Sale x Contribution Percentage x Commission Rate
Payable Commission = $2,000 x 50% x 5%
Payable Commission = $50
Both salespeople would get a $50 commission for their part in making the sale.
9. Calculate the manager's cut
In addition to receiving overrides, managers might also receive a piece of the sales representative's commission as their "cut" for managing the sales team. This would be in addition to whatever overrides they receive.
Typically, the manager's cut is a predetermined proportion of the commission that the representative is liable to pay.
To determine this, multiply the commission that is owed to the representative by the percentage that represents the manager's cut.
Let's say the manager gets 10% of the salesperson's commission, which is $1,000.
Manager's Cut = Payable Commission x Manager's Cut Percentage
Manager's Cut = $1000 x 10%
Manager's Cut = $100
Moreover, it’s essential to provide sales representatives and managers with a comprehensive explanation of the manager's cut policy. This should include the process by which the percentage is decided as well as the method by which the manager's cut will be distributed.
Wrapping Up
Commissions can be hard to figure out. But it plays an essential role in motivating and rewarding your sales reps.
Following the steps in this guide to accurately calculate commissions based on sales performance, commission variables, tiered commission rates, overrides, returns, and more.
By figuring out commissions correctly, you can give your sales team a reason to do their best work, increase sales revenue, and create a culture of success and teamwork in your company!
