How to Calculate Your Draw on Sales Commissions

So, you've landed a great job in sales -- congratulations! Chances are your income will be based on some sort of commission plan. Right away, your company may even offer you a draw against your commission.

Before you buy a new television or take your friends out for burgers with your new windfall, however, let's take a closer look at what commissions are all about and how a draw against commission works.

Getting paid on commission means that your job performance has a direct impact on your paycheck. A draw is a simply a pay advance against expected earnings or commissions. Sales commission structures are usually designed to give an employee some control over how much they earn during a certain time period. It adds a direct incentive to performance: The more you sell, the more money you'll make.

The length of the sales cycle is an important consideration in determining how commissions are paid. A sales cycle is the length of time between making an initial contact with a prospective client and the time that the product or service is exchanged for payment. For some products or services, like retail clothing, shoes, cosmetics and electronics, the sales cycle is short, immediate and often customer-driven. Some products or services require a single cold call, like cutlery or magazine subscriptions.

Other products, like cars, copiers or computer systems, may have sales cycles that last several months. Other industries, such as heavy equipment or process automation systems, may require several years of planning and engineering to complete the sales cycle. And in some fields, such as financial services or pharmaceuticals, sales are based on relationships built with customers over even longer periods of time. Because it can take a while to earn a commission when the sales cycle lasts for months or years at a time, some companies will offer salespeople a draw on their commission to tide them over until actual commissions are paid out.

Fortunately, sales managers consider the length of the sales cycle when putting together your compensation plan. Read on to learn more about different types of sales commission structures.

Sales Commission Structures

Sales compensation packages come in many different types and are calculated in a variety of ways, depending on the industry and the company. A sales compensation agreement usually involves careful negotiation with your employer. Make sure that you have a good understanding of the terms and how your compensation will be calculated.

Most sales commission structures are based on one of these models:

Straight commission. Industries with immediate sales, one-call closes or a closing cycle of less than a month often use a straight commission structure. As an employee, this type of compensation can be risky, unless you're confident in your sales skills or are certain the product will sell. Some retail clothing, cosmetics, office products and even residential real estate, are based on straight commission sales.
Base salary plus commissions. A salesperson receives a regular salary plus performance-based commissions under this structure. Sometimes, companies will increase the base salary and decrease commissions over time, or decrease base salary and increase commissions until the salesperson is on straight commission. This commission structure works well in any field that relies on long-term relationship building or an accumulated expertise, such as national sales for a sportswear manufacturer or an applications specialist for a technology company.
Draw against commission. Salespeople receive regular advances against future commissions, with a limit on the total advance. This commission structure is often used when salespeople have to plan on a long sales cycle and can have an inconsistent cash flow if they're working for straight commission.
Guarantee against commission. The salesperson receives a minimum income even if commissions don't reach that level. This differs from a draw in that the guarantee doesn't have to be repaid. Companies who are offering a new product with an uncertain market or who are trying to establish a presence in a new territory will sometimes offer a guarantee against commission in order to attract proven salespeople.

Since selling complex products with a high price tag often involves a long sales cycle, these industries usually offer draws against commission. Sales representatives for technology-related equipment and systems, pharmaceuticals, heavy machinery, or farm equipment -- even newly minted stockbrokers -- may be offered a draw against commission.

Companies realize that their sales representatives may have difficulty budgeting and meeting their month-to-month living expenses, and will offer a draw to help them out.

This practice also helps companies to attract and retain good sales representatives, while allowing the sales rep to develop confidence in his or her abilities and develop assigned territories.

Read on to learn more about how draws are calculated and taxed.

Calculating Taxes on Sales Commissions

If you'll be receiving a draw on a sales commission, it's very important to understand its pros and cons, how the amount of the draw is calculated, and how taxes are computed.

The primary advantage of a draw against commission is that you, the salesperson, has some regular income and an ongoing incentive to meet sales goals. The disadvantage is that the draw must be paid back if sales commission levels aren't met. On the other hand, the employer may lose the draw if the employee quits.

Your employer will usually have a good idea about your projected income or what you can reasonably expect to earn, based on the territory, sales rep experience and market expectations. The draw is based on a percentage of that figure, and the amount of the percentage varies depending on the industry, the territory, reasonable living expenses and the sales representative's experience.

For example, if your projected commission is $4,000 a month, the company could offer a draw of $500 a week, or $2,000 a month. That means you would be paid $500 a week. At the end of the month, if you met the $4,000 sales goal, you'd be paid an additional $2,000. If sales were $3,000, you would earn an additional $1,000; if sales were $5,000, you'd earn an additional $3,000.

What if your overall commissions fall short of your draw? That depends on the terms of your agreement with your employer. Some companies require repayment of the draw right away, while others allow some additional time or sales cycles to help you establish a territory and make up the draw.

Calculating taxes on sales commissions is relatively simple: The draw and the commission are taxed together as ordinary income. For example, say you earned a $25,000 draw and an additional $50,000 in commission. Total compensation for the year is $75,000, and taxes must be paid at the appropriate income rate.

Some earners may be surprised by their tax bill if they haven't planned for right tax rate all along. For example, if you receive a monthly draw of $2,000, your employer may withhold taxes at the tax rate appropriate for an annual income of $24,000. When you receive a bonus of $50,000 that raises your total income up to another bracket, don't be surprised to discover that you'll be paying Uncle Sam at a higher tax rate.

For more on taxes and other financial obligations, see the links on the next page.

How to Calculate Your Draw on Sales Commissions

Sales Commission Structures

Calculating Taxes on Sales Commissions

Lots More Information

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