How companies determine their commission rates is based on various factors, like average monthly sales, or total profits of the business, etc.
The following is a possible commission rate formula a company might use to determine their commission rate:
commission rate = variable sales compensation / quota
Variable sales compensation is the portion of an employee's earnings that will be variable or subject to fluctuation based on commission. The quota is the revenue an employee needs to make in sales. Some other numbers are required to make this calculation, such as the earnings each employee is estimated to make.
Here is another example to see how to find the commission rate. A company projects sales employees to make $100,000 a year, where 50% of that pay is fixed, and the other 50% is variable. So the quota each sales employee needs to meet is $500,000.
First, we plug in the values:
commission rate = 50,000 / 500,000.
We are dividing the employee's expected income by 2 to get the variable sales compensation value because half of the employee's earnings are variable, which gives us a value of 50,000. Next, we simplify:
commission rate = 0.10
This company has a commission rate of 0.1, or 10%, per sale.
Some companies even place floors and/or ceilings on their commissions. Floors are the minimum number of sales an employee must make before they begin making their commission, and ceilings are a limit to how much an employee can make from the commission. The needs of each business vary, and some will pay out higher percentages for sales than others. Ceilings can be particularly effective in fostering a friendly sales environment founded on teamwork. Everyone is trying to help each other make enough sales to meet their quota rather than outperforming each other and being too competitive.
Profit, Revenue, and Expenses
An important factor in determining commission rates is by calculating their profits, which can tell a company how much it should be paying its employees. Using that information, companies can determine how much of that income is fixed and how much of it an employee will make from their commission. Put simply, profit is the difference between expenses and revenue and is determined by a simple formula:
profit = revenue - expenses
revenue is the earnings from selling a product. If a company sells shirts at $10 a shirt and sells 100 shirts, their revenue is $1,000. However, this does not tell us how much the company earned in profit. We need to determine the expenses of the business. Expenses are the costs of selling a product. This typically involves the cost of materials for the product. So, if each shirt that the company is selling costs $3 to make, and they made 100 shirts, they have $300 in expenses. When we calculate for profit, we subtract expenses from revenue, which in this example, gets us a total of $700 in total profits.
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