Personal Finance Beginner

What is commission?

what is commission

Key Takeaways

  • Commissions are compensation proportionate to the amount of work done or the profit you have helped generate.
  • Incentivizing success with a percentage of sales works in favor of both the company and the salespersons.
  • Commissions are, however, not preferred by some because they do not offer a fixed income at the end of every month.

When you think of income, it is likely that you may think of people who get it in the form of salaries rather than commissions. Yet, so many jobs out there are commission-based. Besides, chances are that you or someone you know will receive a commission at some point in your life.

So, whether or not a large part of your current income is commission-based, it is important to have a basic understanding of how commissions work. When it comes to money, ignorance is seldom bliss.

What is a commission?

Commission refers to compensation that is proportionate to the amount of work done or the profit you have helped generate. But doesn’t that apply to all jobs? How are salaries different then?

A salary based on your performance will probably be a fixed amount. And your performance is only evaluated after the base salary has been paid. With commissions, on the other hand, your pay each month depends on how much you deliver. The evaluation, therefore, is always ongoing.

Commissions are thus a type of variable pay for products or services. So, for example, you earn money based on how many goods you sell, whether you fill your weekly, or monthly quota or have placed enough hires, etc.

Some jobs offer commissions as additional pay—that is, in addition to a monthly salary.

What sort of jobs are commission based?

Sales roles usually function well on a commission payment model. Incentivizing success with a percentage of sales works in favor of both the company and the salespersons. Companies that use the commission model do not have to spend as much to fulfill their revenue goals. On the other hand, if the salesperson sells more stuff, he or she will be paid more.

Commissions work well elsewhere too. In recruiting jobs, you could be paid a percentage of your salary for every candidate you place. As a manager, the incentive is to bring in more business, so you might be incentivized with a commission for new clients. Broker or real estate agent commissions could be tied to the revenue of sales—meaning, their income would vary depending on the kinds of assets and property sold.

While most jobs include a base salary to go with commission incomes, some industries might hire you solely on an incentive structure. These commissions can be distributed monthly, weekly, or even yearly, depending on when they are earned.

Advantages and disadvantages of commission-based pay

Commissions might sound exciting to some and off-putting to others. However, as it is with any other pay structure, commissions have their pros and cons.

The pros

Commission-based pay comes with some uncertainty, but if you can brave it, there are things to look forward to. Some of them are:

  • Flexibility: Gigs that are commission-only give you a significant degree of flexibility and a lot more control over your time. You are free to set your schedule as you need in order to fulfill your sales requirements.
  • Pay tied to revenue: From a company perspective, not having to pay out large salaries with no assurance of revenue is a huge plus. With a commission structure, the company only has to pay up after the contractor is able to establish that they have generated revenue or put out a service or product for the company.
  • Sale increases: Incentive structures motivate employees to work harder and earn extra cash. Sales employees might increase efficiency and bring in more clients for the company when they have the right incentives. When pay is connected to actual results, more often than not, the results get better.

The cons

While commissions are great for many people, they do come with their share of problems. Some of them are listed below.

  • Unpredictable income: Commission-based incomes can fluctuate from month to month. You might do very well for a while but have a dry spell for the rest of the year, for instance. While the opposite is also possible, one must not discount the risks that come with such a payment structure.
  • Unpredictable expenses: More sales means the company has to pay out more money. And commissions have to be paid regularly and on time. It does not help when client payments are not predictable. Consequently, companies often have to finance other operations on top of commission payments without revenue, which can sometimes lead to internal budget deficiencies.
  • Aggressive sales tactics: The need to earn more commissions sometimes ends up causing sales staff to make overly aggressive sales. While that might lead to short-term sales, it could drive away quality, long-term clients. This is oftentimes a managerial nightmare.

How is commission calculated?

To calculate the commission you stand to make, you need to know what the term rate of commission means. Commissions are most commonly given out in terms of percentages. For instance, you could be paid 2.5% of your base salary for every sale, or 1% of the amount of that sale. That’s the rate of commission.

Now that you understand the term, you can use the formula below to calculate the commission you are due:

Commission = Revenue generated by you x Rate of commission

If you earn a fixed salary in addition to commissions, you could use the following formula to calculate your total income:

Income = Base Salary + (Revenue generated by you x Rate of Commission)

Commissions can also be an absolute amount, requiring no calculation. An example of this type of commission would be if you are paid a fixed amount, say an extra ₹500, for every successful recruitment.

Is commission taxed?

Yes, since commissions are indeed income, they are taxed in India. Taxes on commissions are often deducted at the source because the person paying the commission is responsible for the tax payment. Usually, commissions in India are taxed at the rate of 5%, as per Section 194 H of the Income Tax Act.

So, a commission of ₹50,000 will, roughly, attract ₹2,500 in taxes. Those taxes might be deducted at the source. After deduction, the receiving party receives ₹47,500 (that is, ₹50,000 – ₹2,500) in income.

However, taxes are not always deducted at the source or at that rate. It depends on your employment type, contract, or individual state laws.

Conclusion

A commission-based contract offers enough scope for a great work-life balance, but it might not be for everyone. Commissions in themselves are great incentives for improving employee productivity, sales numbers, and revenues for the company. However, many workers prefer a regular and fixed source of income.

While everything has its pros and cons, we urge you to make sure you know what you’re getting into if you are contemplating a commission-based job compensation structure.

FAQs

Why do brokers charge commissions?

Brokers charge commissions for services like trade execution, platform access, research, and customer support. Commissions help cover operational costs and generate revenue for brokers.

How do commissions affect investment returns?

Commissions reduce investment returns by deducting a portion of gains. Higher commissions can significantly impact net returns, especially for frequent traders or smaller investments. Consider cost-effectiveness when choosing a broker.

Are commissions fixed or negotiable?

Commissions can be both fixed and negotiable. Some brokers have set commission structures, while others may offer negotiation flexibility, especially for active or high-volume traders. It’s worth exploring options and discussing with brokers.

How does commission differ from a bonus?

Commission is a fee charged by brokers for services. A bonus is an incentive offered by brokers, often tied to certain criteria like deposits or trades. Commissions are fees paid, while bonuses are rewards received.

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