Commissions can be paid at several different points in the sales cycle. The four most common are on booking, invoicing, receipt of partial payment, or receipt of full payment. Commissions on long projects may be paid in installments throughout the project. The timing of commission payments affects sales force motivation. The ability of the accounting department to compute the commissions promptly and accurately affects their motivation, too. Here are the pros and cons of each type of payment timing.
Rewarding salespeople immediately after they make the sale is the most powerful motivator because it provides immediate positive feedback.
Since you pay commission before you get paid, this can be tough on cash flow. Also, it can be hard to recoup the commission if the order is cancelled or changed - perhaps impossible if the salesperson has left the company or the commission was paid to an independent rep.
Computing this type of commission also creates technical problems. Most accounting and ERP systems don't keep an audit trail of order changes and cancellations, Therefore, you won't know when commission should be adjusted due to order changes. Tracking changes manually is guaranteed to create errors, which will adversely affect sales force motivation, yet very few software packages can automate this method of payment.
Although few companies pay on bookings, some do. Paying on bookings is more common for long projects, such as construction. Some companies combine payment on bookings with one of the other methods paying, for example, half of the commission when the order is booked and the balance when it's invoiced.
Since, after bookings, this is the earliest time to pay, it's the second best motivator. Also, if you compute commissions manually, this is the easiest method to use: every accounting system includes reports of invoices for a month.
You may pay commission on more sales than you get paid for and salespeople have no incentive to help collect receivables. As with payment on bookings, this can be tough on cash flow. That's especially a problem if your product is seasonal, creating lean months when you purchase inventory and fat months afterwards when you get paid.
Also, this method will create problems if your customers frequently pay short, have a high default rate, or frequently return goods. However, you may be able to overcome this by "clawing back" commission if an invoice hasn't been paid in full in a certain number of days.
This is the second most common time to pay commission.
Receipt of full payment
You pay out commission from money you have in hand, so this is good for cash flow. Also, this motivates salespeople to help collect outstanding amounts from customers.
If you have commission software that does this for you, the only con is that, psychologically, it isn't as good a motivator as the methods that pay earlier. If you're computing commissions manually, paying on receipt of full payment can be very time-consuming. Some accounting systems have a clear indication that an invoice has been fully paid; others don't. If yours doesn't, you're left with the very manual process of figuring out which invoices were open last month but are closed this month. Most of the transactions closing the invoice will be payments, so you can figure out which payments fully closed invoices, but a credit memo might also close an invoice, so you need to check those as well.
This is the most common time to pay commission.
Receipt of Partial Payment
This is easier to measure than full payment if you're computing commissions manually, because you don't have to figure out if a payment fully paid an invoice, and credits have no effect on commission due. All you need is a list of payments for the period. Also, it has the advantage that you pay out of what you've received, just as the previous method does - although, in this case, you've incurred all of the expense but perhaps received only part of the cash.
Cons: If your commission rates depend on the product or service being sold, paying on partial payment is very imprecise. There is no way to know to which invoice line(s) a payment applies. If the lines have different rates, or the invoice includes non-commissionable items, freight or tax, the commission paid will be only approximate.
Not all commission software supports this method of computation. Furthermore, if short payments are generally due to disputes, salespeople will have less motivation to resolve those disputes because they've received part - perhaps most - of their commission.
This timing is less common than either payment of receipt of full payment or payment on invoicing, but more common than payment on bookings. If most customers pay most invoices in full, this has about the same effect as paying on receipt of full payment, so you might end up choosing based on which method is easier to compute.
This method is used for long-term projects, such as construction, service contracts, and subscriptions. The trigger to pay commission may be a G/L transaction to recognize revenue, an entry in project management software, or the passage of a certain amount of time. This method is usually used with one of the other methods, most often payment on bookings. It is the least common method.
Commission payments are usually linked to the receipt of a customer payment, so you're paying with money you have. Salespeople don't have to wait until the end of a long project to get paid, which would be a very poor motivator, and it encourages them to keep the customer happy throughout the term of service.
Commission reports available in most ERP systems don't bring in data about projects. Frequently, projects are tracked either manually or with a different software package. Therefore, this method can involve a lot of manual work, which leads to errors, delays in commissions, and many days of work each period in the accounting department.
Timing of commission payments should motivate the sales force and also be practical to compute accurately and promptly. We've reviewed the alternatives here. There's no right method for everyone, and each involves trade-offs. The method you choose will depend on the unique requirements of your company.