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How to pay employees based on commission

Sunday, December 06, 2015

A small business guide to commission payments

When it comes to employee compensation at your small business, there are lots of ways to do it. You could choose hourly pay, salary pay, or even a commission model. Sales-based jobs typically have commissioned employees. So, in this article, we’ll look at commission – what it is, the different types of commissions, and the steps to implement commission pay for employees. First, let’s look at what a commission is.

What’s a commission?

A commission is a sum of money that a business pays to its employee for meeting or exceeding a particular goal. Usually, this is tied to a sale of a good or service while representing the company. Commissions are often additional income on top of what the sales employee makes as a salary or hourly wage. Depending on the company, the salesperson might be paid a base salary and then a commission. These commissions are sometimes a set dollar amount or can be a percentage of the sales revenue. Commissions are utilized by businesses in order to incentivize employees to produce more sales while recognizing those top performers within the organization. Many organizations adopt a commission pay structure because of how well it works to reward employees for meeting and exceeding sales goals. Note that the Department of Labor and the Fair Labor Standards Act (FLSA) does not require the payment of sales commissions. Generally speaking, workers are entitled to any unpaid commissions if they’re terminated from a company.

Now let’s take a closer look at the types of commission structures.

Types of commission pay

Commission rates can be structured a few different ways. Let’s examine the most common types of commission plans businesses use:

Salary plus commission

One of the most common structures for commission sales is salary plus commission. In this type of commission, the employee receives a base salary and then a commission on top of that base salary. Employees may find this type of compensation beneficial because it provides them a guarantee of income regardless of their sales. This type of commission is popular in certain sales industries and comes with the expectation that not all of the time spent by the employee will be solely making sales.

Straight commission

In this commission model, the employee’s only form of payment is the commission they make. This compensation is directly tied to the number of sales the employee makes. The formula is easy: sell more, make more. Often, there’s no cap to the amount of money a straight commission salesperson can make. Because the nature of business is cyclical, there may be slower times of the year, so employees on this type of commission structure will need to budget effectively. One example of the straight commission structure is real estate agents, whose income is tied to the houses they sell.

Draw against commission

The third structure is called draw against commission. In this payment type, an employee is given a specific amount of money to start working, known as the draw. If they sell more than this amount, it becomes their income with commission on top of that amount. However, if they don’t sell enough, they must return the money back to the employer. This may seem pretty risky and that’s because it can be for some employees. However, it can also be used as a motivational tool for employees as a driving force to hit their sales goal.

Residual commission

The last popular type of commission is residual commission. This is an amount of money that an employee makes after the client makes their first purchase. It rewards the salesperson for the loyalty of the customer, even if the salesperson leaves that company. Residual commissions are common in the real estate and insurance industries as a continual payment from clients toward their property or insurance creates a residual commission for the salesperson.

You’ve seen the various commission structures, and now you’re ready to pay your employees a commission. What next? Let’s find out.

How do I pay my employees a commission?

To pay your employees their earned commissions, you’ll need to outline your process. For many businesses, these are simply steps that can help guide your own process. You'll need to keep accurate records on the employee's sales numbers, the number of hours they’ve worked in a given pay period, the company’s commission schedule, and ensure your business is in compliance with the federal minimum wage laws.

One of the most important parts of the federal law is knowing who is exempt and non-exempt. An example of an exempt employee is an “outside salesperson” who regularly works more than half their working time away from the employer’s place of business, and sells items or obtains orders for products or services. However, inside salespeople can be exempt too, as long as they earn more than 1.5 times the minimum wage, and more than half of the employee’s compensation are commission earnings. Non-exempt employees, though, are entitled to benefits and may receive overtime pay for any overtime hours worked in a given workweek.

To pay employees a commission, here’s what you’ll need to do:

Develop your commission structure – After learning about all the different types of commission structures, you’ll need to decide which is best for your business. Will you pay a percentage of each sale to the salesperson? Will your employees’ commissions be a flat rate for each sale? Once you make a determination on the commission structure, you’ll need to record it and make the commission terms clear to all of your employees.

Set a payment schedule – Depending on your state, there may be certain payment laws that dictate when you pay commissions to employees. While some businesses may hold commissions for as long as they can before paying employees, other businesses try to pay their salespeople as quickly as possible as a motivational tool to sell more products or services. Like your commission structure, you’ll want to put your commission schedule in writing to help avoid any future confusion from your salespeople.

Create a record keeping system for commissions payments – Record keeping is important in any business, but even more important when you’re paying employees based on their performance. Therefore, you’ll want to make sure you set up a system that includes all entries and record entries as soon as a completed sale takes place. In this entry, you’ll want to record the date of sale, a description of the product or service, the salesperson’s name, the amount of the total sale, and the amount of commission the employee gets.

Calculate commissions – After recording all of these sales, you’ll want to determine the amounts you owe to your salespeople. To do this, use the record keeping system to add up all of the commissions each employee earned, minus any taxes or other deductions they may have.

What are the benefits of commissions for an employer?

We’ve talked about the benefits of commissions for an employee, but how about for you, the employer? There are a few benefits for your business for paying commissions:

Pay out on performance – Since you pay employees who receive commission based on their performance, you’ll pay when they bring business to you (above and beyond a base salary, if applicable). You’ll also be able to find out who your best employees are based on their drive and performance. Again, because their performance is tied to your company’s performance, it can be a win-win strategy for both employer and employee.

Lower base pay – Since commission pay is different from a salaried position, you may find you’ll cut the total payroll outlay by paying your employees on commission. You’ll be able to pay them less at the start, knowing that their incentive to work is tied to how much they can earn in commissions.

Weed out lax producers – Finally, you’ll also be able to tell who isn’t getting the job done. Since commissions are an indication of performance, you can see who the lowest-performing individuals are just based on their sales numbers. That can inform your staffing decisions or help you put an action plan in place for some who just aren’t meeting their sales quotas.

As you can see, paying your employees on a commission basis can be a great way to go, especially if you rely on salespeople in your business. You motivate employees to work harder and have a shared interest in the business’s sales goals because it financially benefits them. Of course, you’ll need to evaluate your own business’s needs to determine which commission structure will work best for your business. But the bottom line when it comes to commission is the more they sell for your company, the more they earn. And that is good for everyone.

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