Most companies ignore the benefit of paying a higher commission to salespeople for securing prepaid orders and focusing on faster turnover rate products. These companies simply ignore their daily cost of money and its impact on the product’s gross profit. They fail to account for the company’s financing costs of inventory and the company's costs to finance receivables. For instance, if the product is retained for months on end, the salesperson still gets the same commission. Consequently, if a customer takes 30, 60 or even 90 days to pay an invoice, again the salesperson still gets the same commission. However, doesn’t it just make sense that the company’s sales team should be compensated for ensuring that inventory moves quickly and that customers pay faster? It most certainly does!
The intention is not to imply that salespeople should be penalized for late customer payments – although there are some who advocate this approach. However, I am stating that your company should pay your salespeople a higher commission for prepaid orders and for their ability to move faster turnover rate products. When salespeople ensure that products sell quickly, they effectively reduce the company’s inventory holding costs.. When salespeople get customers to pay earlier, they reduce the company’s receivables financing costs and improve the company's cash flow.
In order to get an appreciation for these costs, please refer to the table below that outlines a company’s theoretical costs to finance its inventory and its receivables. This example is taken from yesterday’s post entitled Strategic Planning: Reducing Inventory & Receivable Financing Costs. The table below shows what the company’s daily cost of money would be at a 9% yearly interest rate on a product with COGS of $27,000.00. The first table outlines the company’s inventory financing costs, while the second outlines the company’s receivables financing costs. Finally, a total is provided that sums up the company's costs on this particular sale.
To learn more about your costs of capital, please see: Cost of Capital, Cost of Borrowing Money and Your Bottom Line
Incentivize Sales to Reduce These Costs!
It’s important to note that the above table only shows the company’s financing costs of inventory and its costs to support its receivables. We haven’t actually determined the company’s overall inventory holding costs. These costs would include the costs of damage, obsolescence and ruined inventory. Therefore, an argument could be made that the costs above would even be higher. However, if your salespeople increase your inventory turnover rates and use incentives to secure prepayment from customers, then these aforementioned costs can be reduced. Sell products quicker and these costs are lowered. Get customers to pay sooner, and these costs are lowered. However, now the question becomes.....
“how much should the salesperson be compensated when they sell faster moving product lines and pursue prompt payment initiatives with customers”?
In order to answer this question, consider the approach I took in my post: Sales Management Strategies: Getting Sales to Sell Slow Moving Inventory. In it I showed how a company could ensure its salespeople sell slow moving inventory by using a sales team “penalty” for the amount of time, and subsequent cost, of holding inventory for extended periods. The approach was to summarize the company’s inventory holding costs by product line and impose the sales penalty based on the company’s costs to hold slow moving inventory.
So, if one uses a penalty for slow moving inventory, then one should use a reward structure for prompt payments on invoices and for guaranteeing faster inventory turnover rates. This will incentivize your salespeople to increase your inventory turnover rates and to use prompt payment incentives and discounts to get customers to pay sooner.
As for how much higher the commissions should be for prepaid orders & faster turnover rate products, well, that’s entirely up to you. If your company rewards sales on gross profit per transaction, then you probably pay a 3% commission on the gross profit generated by each sale. If you pay on sales totals, you probably pay a commission of 2%. Therefore, in either situation, you could increase the commission rate by 0.5% making it 3.5% and 2.5% - that is of course if your gross profit allows it! In order to determine what incentive to give your sales people, start by defining your inventory financing costs and your receivables costs as outlined by the table and example above. Define what these costs are and reward your sales people for aggressively reducing these costs.
To read more about paying salespeople commission, please read:Should Your Company Pay Commission on Sales Totals or Gross Profit?
To download a sample excel sheet on commissions, please read:Small Business Sales Management: Sample Commissions Excel Table
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