Draw Against Commission: Definition, Types, Pros & Cons
For sales positions, paychecks are often determined by commission. Therefore, the right commission structure is crucial for attracting and retaining qualified sales reps while protecting the employer’s financial interests.
A draw against commission is a type of pay structure that guarantees minimum income. When used effectively, it helps motivate employees and gives them enough financial security to achieve their best performance. This article covers the different types of draws and their potential benefits and drawbacks.
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What is a Draw Against Commission?
A draw is a compensation structure often used for sales representatives. It guarantees a set amount of advanced income for each paycheck. A draw can be considered a cash advance for sales reps and an incentive for boosting sales performance.
At the end of each sales period, the draw is deducted from any earned commission. If a rep earns more commission than the draw amount, they keep the balance. If they fail to match the draw amount, the discrepancy may be carried forward into the next month as accrued debt.
Types of Draw Against Commission
There are two common types of draws — recoverable and non-recoverable. Both offer their own benefits and drawbacks depending on the circumstances.
A recoverable draw is the more prevalent of the two. It guarantees employees a minimum income each pay cycle.
However, it must be repaid by the salesperson’s commission at the end of the pay cycle. If the salesperson does not meet the draw amount, they will carry this debt to the next pay cycle.
This type of draw also guarantees employees a minimum income each pay period. However, the salesperson is not required to repay the draw if they fall short of sales targets.
Since the employer doesn’t expect the employee to pay back a non-recoverable draw, they’re considered less motivating than recoverable draws. That’s why non-recoverable draws are often used as short-term incentives or to cover expenses for new hires.
How Does a Draw Against Commission Work?
The employer sets a fixed amount of draw for the employee. At the end of the sales cycle, this amount is deducted from any earned commission.
If the salesperson’s commission exceeds the draw, they will earn a higher salary. However, if they earn less commission than the draw amount, the employee owes this debt to the employer.
A commission draw is often used in industries with extended sales cycles. For example, a construction materials sales rep may have to build relationships with contractors working on projects that span many months or years. Instead of waiting for a final payout after the deal is completed, a draw guarantees a base salary throughout the cycle.
When to Use a Draw Against Commission
Different industries or positions may require different types of draws against commission. Most companies use commission draws in the following situations:
- To onboard new employees: It may take time for a new salesperson to build up their sales network and start earning a commission. A draw gives a salesperson the financial backing to be productive and learn the ropes in their new position.
- To wean salespeople onto straight commission plans: As the salesperson gains experience and builds out their sales network, they may begin to earn a higher commission. Companies may shift these employees to an exclusive commission plan to incentivize performance further.
- To provide stability during unpredictable periods: A lack of sales doesn’t always indicate poor performance. Industry disruptions or external events may lead to slow periods. A draw helps teams weather these storms.
Benefits of a Draw Against Commission
There are many reasons why a company might want to implement a draw. These reasons include:
- It acts as a benchmark: A draw is a clear starting point for sales representatives to target. It serves as a reminder for employees of the basic expectation they should meet.
- It incentivizes sales: Employees know that they must match the draw, or they’ll accrue debt over time. On the other hand, if they exceed the draw, they can take home the extra commission.
- It provides income stability over long sales cycles or disruptions: Some periods of the year are better for sales than others. Likewise, some industries have a long sales cycle that extends the time a salesperson must wait for their commission. The draw system covers expenses and relieves pressure during the slow months.
Drawbacks of a Draw Against Commission
Sometimes, a draw is not the ideal pay structure for the employer or employee. Potential disadvantages include:
- Employees may accumulate debt: In the case of a recoverable draw, underperformance may cause the employee to accrue debt over multiple pay cycles.
- Employers will cover the cost of underperforming sales reps: If a salesperson consistently fails to earn a commission, they won’t be able to pay back the draw amount. If they leave or are terminated, the employer must cover the deficiency.
- It only guarantees a minimum salary: Draws are intended to motivate higher sales performance, so they’re often set lower than fixed salaries.
Draw Against Commissions Example
Let’s say a sales representative recently joined a company that sells design software. She is eligible for a $2,500 recoverable draw each month.
During the first month, she earned $1,500 in sales commissions. The company paid her the $1,500 in sales commission and issued $1,000 of the draw allowance. Since the sales rep didn’t hit the $2,500 sales target, she now owes the company a balance of $1,000. This loan amount carries over to the next month.
Then, suppose she closed a major deal the next pay period and earned $4,000 in sales commissions. At payout, the $1,000 draw she owed the previous month would first be recovered by the company. Then, the company would issue her an additional $500 on top of the original draw amount of $2,500. In the end, her total payout for the month would be $3,000.
But what if the draw was non-recoverable? In this case, the salesperson wouldn’t need to pay back the $1,000 draw money from the first month. In the second month, she would receive the full $4,000 in sales commissions.
A draw against commission guarantees sales representatives an income outside their earned commission. If it’s a non-recoverable draw, then it doesn’t need to be repaid. However, recoverable draws are more common and are deducted from any earned commission at the end of the pay cycle.
A draw can serve as a beneficial pay structure for many companies and their employees. However, it’s only suitable for some situations. Therefore, it must be carefully considered in terms of sales strategies and organizational objectives. In addition, accountants should pay close attention to how it affects the tax requirements for the company.
FAQs on Draw Against Commission
Is draw against commission good?
A draw has several benefits for employers and employees, depending on the situation. It guarantees a minimum income and can help cover living expenses while sales reps get up to speed. It can also benefit employers by helping them to attract and retain qualified sales representatives.
How is salary draw calculated?
The employer sets the draw according to the job requirements. At the end of the month, the draw is deducted from any commission the employee earns. If there’s a deficit, this amount becomes debt carried over to the following month.
Is a commission draw considered income?
Draw and commissions are calculated together for income taxes. For example, if an employee earns a $30,000 draw and $40,000 in commissions, their taxable income is $70,000.
What is a forgivable draw against commission?
A forgivable draw means the employee isn’t required to pay it back if they don’t meet sales targets or leave the company. In this case, the employer bears the financial loss.