Executive Summary: This article delves into the importance and calculation of the sales compensation to revenue ratio, exploring how it impacts the balance between motivating the sales team and maintaining profit margins. It provides an in-depth understanding of sales compensation and revenue, explains how the ratio is calculated, and discusses the factors that can affect it. The article highlights six key benefits of calculating the sales compensation to revenue ratio.
Perfecting the sales compensation plan is a tricky business!
You want to pay your sales team competitive rates, but at the same time, you want to avoid overpaying them to the point where their payments eat into your profit margins.
In this case, the sales compensation to revenue ratio can act as a helpful metric to finetune this balancing act. It also works as a justification for the payments you make to salespersons, whether it is high or low.
In this article, we’ll understand what sales compensation, revenue, and sales compensation to revenue ratio are. We’ll then cover the main factors that affect it and also look at the major benefits of calculating this ratio.
What is Sales Compensation?
Sales compensation is a payment plan followed by businesses to remunerate salespersons for the work done against some established targets.
It contains three primary elements:
- A fixed base salary.
- Commission from sales.
- Other monetary incentives, such as a bonus linked to their performance.
The ratio of the three components varies from industry to industry and company to company depending on the unique factors identified while formulating the sales compensation plan.
The objective is to offer some financial cushioning to offer job security to salespersons while also blending in attractive incentives and payouts to motivate them to perform above and beyond.
What is Revenue?
Revenue, also known as sales in the income statement, is the total sum generated from day-to-day business operations and activities.
It indicates the gross income or top-line amount from which expenditures are deducted to compute the net income. While calculating net revenue, you will also have to deduct any discounts, allowances, and returns offered during the period.
What is the Sales Compensation to Revenue Ratio?
Now that you have a basic understanding of sales compensation and revenue let’s put them together to take a closer look at what constitutes the sales compensation to revenue ratio.
As the name indicates, a sales compensation to revenue ratio takes into account the total salaries (fixed and variable) of the sales employees and divides it by the total sales revenue, that is, the number of bookings.
In a formula form, it would look something like this:
It results in a numerical value that correlates what you pay to your sales team and what you gain from them. When converted into a percentage form, it offers visibility to your income and expenses per dollar or per $100.
For instance, if the sales compensation to revenue ratio is 2.4%, then you are compensating the sales force with 2.9 cents for every dollar they generate as revenue.
What are the Key Factors That Affect Sales Compensation to Revenue Ratio
While at first glance, it may appear that sales compensation to revenue ratio will have only two factors, namely, sales compensation and revenue, there are a few other underlying factors that come to play.
In fact, this ratio can change with the change in any of the following variables:
- Base pay levels.
- Target total compensation.
- Quota attainment levels.
- Quota setting and allocation.
- Sales compensation plan pay curve shape.
- Sales crediting rules.
- Sizing and deployment of sales teams.
These are just the direct factors. The sales compensation to revenue ratio could also vary depending on seasonality, marketability, and other factors.
Top 6 Benefits of Calculating Sales Compensation to Revenue Ratio
Calculating the sales compensation to revenue ratio can attract the following benefits:
1. Measures productivity
The sales compensation to revenue ratio is nothing short of a tool to measure the returns on the investments made into the sales force.
It helps businesses identify how much they gain for every dollar they invest in their sales team’s compensation plan. As such, it can be seen as a measure of their productivity.
Check out 11 sales compensation benchmarks you can use in 2023.
2. Helps with benchmarking
Since the sales compensation to revenue ratio sheds light on productivity and performance metrics, it can be useful for benchmarking.
You can establish thresholds depending on the industry standards for your industry and organizational structure. At the same time, you also track this ratio over a period to establish an organization-specific benchmark.
3. Highlights expectation gaps
Once you have identified the sales compensation to revenue ratio benchmarks, you can use them to identify the strengths and weaknesses of your sales team (or the sales compensation plan).
For instance, if the ratio is too high, it could indicate that you are paying more than your salespeople deserve. On the other hand, a sales compensation to revenue ratio that is very low could mean that you are underpaying your sales team, which could be sapping their performance.
However, that’s just a preliminary understanding of the ratio.
While working with this value and deep-diving into the core issues, you may notice that the quota set is too high or that your team is far too big.
4. Motivates sales staff
The sales compensation to revenue ratio aligns organizational goals with sales objectives.
By linking the two together, salespersons can realize their impact on the organization (in terms of revenue) and be rewarded for their efforts. It also eliminates any conflict of interest as they are less likely to report inflated bookings just to meet their quota.
As a result, they would be highly motivated to deliver results that conform to business goals while satisfying their personal goals of financial growth.
5. Realigns business profitability
The value offers a high-level view of what percentage of sales revenue goes into sales compensation. As such, it allows businesses to maintain healthy profit margins where salespeople get their due without losing focus of the profit goals.
6. Boosts forecasting accuracy
By accounting for the sales compensation to revenue ratio, businesses can also make effective sales performance or revenue forecasts.
As mentioned, factors like market demand, seasonality, etc., can change the sales comp to revenue ratio. In such situations, businesses can dynamically adjust the values to forecast any changes in the revenue or the sales compensation plan.
Wrap Up
The sales compensation to revenue ratio can be an excellent addition to your sales metrics dashboard. It allows businesses to compute the sales compensation ROI.
However, remember not to think of it as the end-all-be-all metric to measure all things sales.
You must pair it with other performance and productivity metrics to get a holistic idea of what every salesperson brings to the table.
It also helps you benchmark the overall sales team performance as a singular unit so that you can work out ways to maximize their value.
