How to Structure Sales Commission for a Small Business in Australia

Sales commission can work extremely well for a small business when the structure is easy to understand and the numbers make commercial sense.

It can also become a source of constant disagreement when the rules have been put together quickly.

A business owner might start with what sounds like a simple arrangement: pay the salesperson 10% of every sale. Before long, several questions usually emerge. Is the commission calculated on revenue or profit? Does the calculation include GST? What happens if the customer never pays? What if the salesperson gives away too much margin to close the deal? What happens when two employees contribute to the same sale?

These questions are much easier to answer before the commission arrangement starts.

For most Australian small businesses, there is little benefit in creating a complicated incentive plan. The better approach is usually to build something the salesperson can understand, the owner can afford and the bookkeeper or payroll team can calculate without spending hours interpreting the rules.

Start with what you want the salesperson to earn

One of the most common mistakes is starting with the commission percentage.

Instead of asking whether the business should pay 5%, 8% or 10%, start by deciding what a good salesperson should reasonably earn when they achieve the level of sales you expect from the role.

Suppose you employ a salesperson on a base salary of $90,000 and believe that someone performing well in the role should have the opportunity to earn another $30,000 in commission.

Their remuneration would look like this:

Assume you expect the salesperson to generate $600,000 of new sales each year.

The implied commission rate is:

$30,000 ÷ $600,000 = 5%

You now have a sensible starting point.

The next step is to determine whether paying 5% on those sales still leaves enough money in the business.

Work backwards from your margin

This calculation matters considerably more to a small business than whether another company happens to pay 5% or 7%.

Imagine your average sale is $20,000 and your gross margin is 50%.

That sale generates approximately $10,000 of gross profit before overheads.

A 5% commission on revenue would cost:

$20,000 × 5% = $1,000

The business therefore retains $9,000 of gross profit after the commission payment, before considering other operating expenses.

Now imagine the same $20,000 sale only produces a 15% gross margin.

Gross profit is now $3,000, while the commission remains $1,000.

The salesperson is receiving one-third of the gross profit generated by the transaction.

That may still be acceptable in some businesses, but the owner should know that before agreeing to the commission rate.

This is why commission should be modelled using the economics of your own business rather than copied from another company's plan.

Revenue commission is often the easiest structure

For many small businesses, a percentage of revenue is the easiest arrangement to administer.

For example:

Commission = 5% of eligible new sales revenue excluding GST

If the salesperson generates $50,000 of eligible sales during the month, their commission is $2,500.

The salesperson can calculate it, the owner can check it and payroll can process it.

A revenue-based structure works particularly well when margins are reasonably consistent and salespeople do not have significant discretion over pricing.

It becomes less effective when one sale might generate a 50% margin while another generates only 10%.

Commission on gross profit can work when margins vary

If salespeople have considerable ability to negotiate prices and discounts, paying commission on gross profit may produce better behaviour.

Suppose a salesperson closes a $20,000 transaction with $12,000 of direct costs.

The gross profit is:

$20,000 − $12,000 = $8,000

If the business pays 15% of gross profit, the salesperson receives:

$8,000 × 15% = $1,200

This gives the salesperson a reason to think about the quality of the sale rather than focusing entirely on revenue.

A salesperson who unnecessarily gives a customer a large discount will reduce their own commission as well as the company's profit.

The downside is administration.

If your business cannot calculate gross profit consistently for each sale, introducing a gross-profit commission plan can create more arguments than it solves.

In that situation, a revenue-based commission with a simple minimum-margin requirement may work better.

A margin rule can keep things simple

You could pay 5% of eligible sales revenue provided the transaction achieves at least a 30% gross margin.

Sales between 20% and 30% margin might receive a reduced commission of 2.5%, while anything below 20% could require approval before commission is payable.

The salesperson still has an easy calculation to follow, but there is a reason to protect pricing.

The exact thresholds will depend on the economics of the business.

A company routinely operating at 20% margins obviously should not copy the thresholds of a business operating at 60%.

Decide whether new and existing customers should pay the same commission

Not every dollar of revenue requires the same amount of work.

A salesperson might spend three months prospecting, meeting and negotiating to win a new customer. Six months later, the same customer places a routine repeat order with very little additional sales effort.

Paying exactly the same commission on both transactions may not make sense.

A small business could use something like:

These percentages are only examples.

If the main objective is acquiring new customers, the commission plan should make new business particularly attractive.

If retaining customers is difficult and commercially important, renewals may deserve a more substantial incentive.

The structure should reflect how your business actually makes money.

Give the salesperson a clear target

A commission percentage tells the employee what they receive from an individual sale, but it does not necessarily tell them what good annual performance looks like.

A sales target provides that context.

Using our earlier example, the arrangement could be:

Base salary: $90,000

Target commission: $30,000

On-target earnings: $120,000

Annual sales target: $600,000

Commission rate: 5%

The employee can immediately understand that generating $600,000 of eligible sales should result in approximately $30,000 of commission and total remuneration of $120,000.

The target should be based on something realistic.

Look at historical sales, available customers, average transaction size, lead volumes, sales-cycle length and the amount of time the employee actually has available for selling.

Advertising an attractive commission opportunity means very little if the target required to earn it is practically impossible.

Decide whether commission starts immediately

For many small businesses, paying commission from the first eligible sale is the simplest arrangement.

At a 5% commission rate, $100,000 of sales produces $5,000 of commission and $600,000 produces $30,000.

Another option is to introduce a threshold.

For example, the employee might need to generate $20,000 of sales in a month before commission starts.

Thresholds can make sense where the business already receives a predictable level of incoming orders and the salesperson is primarily being rewarded for generating sales above that level.

However, an excessively high threshold can make the incentive ineffective. If the employee concludes halfway through the month that they have no realistic chance of reaching it, the commission plan provides very little motivation for the remainder of that period.

Reward people who significantly exceed target

Suppose your salesperson reaches their $600,000 annual target in October.

You probably want them to keep selling rather than deciding that additional sales can wait until next year.

An accelerator can help.

For example:

Importantly, the higher rate does not necessarily need to apply retrospectively to every dollar sold.

The 7% rate could apply only to sales between $600,001 and $750,000, with the 9% rate applying only to sales above $750,000.

That distinction should be made very clear in the commission plan.

A large commission payment is not necessarily a problem

Small-business owners can become uncomfortable when a salesperson has an exceptional year and the commission calculation suddenly produces a much larger payment than expected.

Before changing the rules, look at what the business received in return.

If someone earns $80,000 in commission after generating $1.5 million of profitable new business that the company would not otherwise have won, the commission payment may represent an excellent commercial outcome.

The important calculation is not simply the amount paid to the employee.

The owner should consider the revenue, gross profit and longer-term customer value generated in return.

If you would be unhappy paying the commission produced by exceptional performance, change the formula before the plan starts rather than after the employee has achieved the result.

Be careful with commission caps

A business might decide that annual commission cannot exceed $50,000.

This certainly limits the company's cost, but it can create an obvious problem.

If the salesperson reaches the $50,000 cap in October, there is much less financial reason for them to push hard to close additional sales during November and December.

For genuine sales positions, it can be better to design a commission formula that remains commercially affordable even when performance is exceptional.

If the concern is one unusually large transaction, deal with that specifically.

For example, the plan could state that transactions above a particular value require an agreed commission treatment before the sale is finalised.

This protects the business against an unintended windfall without limiting the reward for normal high performance.

Decide exactly when commission is earned

A customer saying yes does not necessarily mean the business has received any money.

Your commission plan should explain when a transaction becomes eligible.

Depending on the business, this might happen when the customer signs the contract, when an invoice is issued, when the product is delivered or when the customer pays.

For a small business where cash flow matters, paying commission after customer payment can be attractive.

For example, the plan could provide that commission is calculated on eligible customer payments received during the relevant commission period.

This prevents the business from paying commission on invoices that ultimately become bad debts.

However, think about how much control the salesperson has over collections. If an otherwise excellent salesperson regularly loses commission because the accounts team is slow to collect invoices, the arrangement will quickly become frustrating.

Make it clear whether GST is included

This is a small detail that can cause unnecessary disagreements.

If a customer receives an invoice for $22,000 including GST, is the salesperson's 5% commission calculated on $22,000 or the $20,000 GST-exclusive sale?

The commission plan should state this clearly.

For most revenue-based arrangements, a simple definition such as eligible sales revenue excluding GST removes the ambiguity.

Decide what happens with refunds and cancellations

Suppose a salesperson earns $2,000 of commission and the customer subsequently cancels the order and receives a full refund.

The business needs a rule for dealing with that situation.

One approach is to adjust the commission in the next payment period.

Any adjustment or clawback arrangement needs to be carefully documented and should comply with Australian employment requirements.

The salesperson should also not automatically carry every commercial risk that arises after the sale. If a customer cancels because the company failed to deliver the product properly, reducing the salesperson's remuneration may not produce a fair or sensible outcome.

Agree on how shared sales will work

This issue can arise even in a very small business.

One employee generates the lead, another employee conducts the meeting and the owner eventually negotiates and closes the deal.

Everyone may reasonably feel they contributed.

A simple rule might provide that the employee recorded as the lead salesperson receives the commission unless a split has been agreed before the transaction closes.

Alternatively, the business could split commission between two employees where both made a substantial contribution.

The exact approach matters less than having a consistent rule before the disagreement occurs.

Keep the plan simple enough to explain

A salesperson should not need an elaborate spreadsheet to understand how they earn commission.

If the plan includes five performance measures, multiple thresholds, several multipliers, individual discretion and a long list of exceptions, the employee will struggle to connect their daily behaviour with the remuneration outcome.

For many small businesses, something as straightforward as the following can work well:

The salesperson receives 5% of eligible new sales revenue excluding GST, provided the transaction meets the minimum gross-margin requirement. Higher commission rates apply after the annual sales target is exceeded.

There can be additional rules dealing with unusual circumstances, but the basic commercial proposition should remain easy to understand.

Put the arrangement in writing

A small business does not necessarily need a lengthy sales incentive policy, but relying on a verbal conversation is risky.

The written plan should explain at least:

• the commission rate and sales target;
• which sales qualify for commission;
• whether GST is excluded;
• any minimum margin requirements;
• when commission is earned and paid;
• how cancellations and refunds are treated;
• how shared sales are handled;
• what happens with unusually large transactions;
• what happens when employment ends; and
• who approves the final calculation.

The business should obtain appropriate employment-law advice when establishing provisions dealing with matters such as deductions, clawbacks and termination.

Australian minimum employment requirements still apply

Commission does not provide a general way around Australia's minimum employment entitlements.

Before deciding on the base salary and commission opportunity, a small business should establish whether the employee is covered by a modern award, enterprise agreement or the national minimum wage framework.

The applicable rules can differ depending on the employee's occupation and industry.

This becomes particularly important if the business is considering commission-only remuneration or setting a relatively low base salary because it expects the employee to earn substantial commission.

The potential to earn a large commission should not simply be assumed to correct an arrangement that does not otherwise meet applicable minimum employment requirements.

Checking the employee's award coverage and minimum entitlements should therefore happen before the commission plan is finalised.

A commission structure a small business could actually use

Consider a small Australian B2B services company.

The salesperson might have the following arrangement:

The actual percentages and dollar amounts need to reflect the business, industry and role.

What matters is that everyone can understand how the arrangement works.

Test the numbers before giving the plan to an employee

A simple spreadsheet can prevent a lot of problems.

Model what happens when the salesperson has a poor year, an average year, a good year and an exceptional year.

Using the example above:

Then add the expected gross profit at each level.

The owner should be comfortable with the commission cost at every point.

If $900,000 of sales produces $53,000 of commission and the business is delighted with the resulting profit, the structure is doing its job.

If the same result leaves very little profit for the business, the commission formula needs more work.

You should also test unusual situations before the plan starts. Consider what happens if the employee closes one exceptionally large transaction, a customer cancels, two employees claim the same sale or someone resigns with several transactions still in progress.

It is much easier to agree on these rules before real money is involved.

What a good small-business commission plan looks like

Small businesses rarely need the most sophisticated sales commission structure.

They need one that works.

A salesperson should be able to understand what they need to achieve, roughly calculate what they will earn and see a worthwhile financial benefit from producing stronger results.

The business owner should be able to understand the cost, protect an appropriate level of margin and remain comfortable paying considerably more commission when considerably more value has been created.

If you can explain the arrangement to a new salesperson in a few minutes, calculate it without an overly complicated spreadsheet and remain happy with the economics when the employee has an exceptional year, you probably have the foundations of a good commission plan.