Employee compensation comes in many forms. Businesses that want to motivate employees to boost company revenues while concurrently controlling labor costs often turn to some kind of incentive pay. Employees may earn mixtures of salary and commissions or bonuses or may simply earn straight commission. This makes their pay impossible to predict. However, their effective salary or pay maintains a relationship with company revenues and often the specific revenues individual employees generate.
For various reasons, both workers and employers try to estimate their effective annual earnings. Employees who receive incentive pay -- particularly those who work on straight commission as real estate agents and automotive salespeople often do -- don't have actual salaries. Instead they may derive their effective pay from averages of prior years or quarters, or from sales projection figures based on business and economic trends.
Employees usually want an estimate of their effective annual salaries to help make important life decisions. Effective earnings influence purchasing decisions, loans and investments. Banks require salary information when considering loan and credit card applications. Employers usually want projections of how much they will pay in labor costs each year which include commissions, bonuses and other incentives. Accountants, business owners and shareholders usually want estimates of their total operating costs to help get a clear picture of a company's liabilities, earning potential and overall performance.
Workers on straight commission have the easiest time computing their effective salaries. If a worker receives 10 percent of her sales revenues and she sells an average of $100,000 per month, then she earns $10,000 a month and can assume an effective salary of $120,000 per year. In cases of mixed base salary and commission, calculations can become more complicated. A worker with a base salary of $50,000 per year who earns 10 percent commissions on sales and generates an average of $10,000 per month in sales revenues typically earns $1,000 per month commission. Her $12,000 a year in commissions increase her total effective pay to $62,000 a year, and her salary constitutes 52 percent of the revenue she generates.
Employers like incentive pay systems for a number of reasons, including driving salespeople to work hard and increase their sales. It also has the added advantage of managing labor costs. Because salespeople on straight commission get paid a fixed percentage of their sales, companies can rest assured that their labor expenditures will always fall within a range they can afford. An organization paying a 10 percent commission spends only 10 percent of revenues on labor whether an employee generates $10,000 in sales or $100,000. This ensures the employee's cost is always less than the revenues she brings in, making her a profitable member of the team.
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