In these recessionary times, many companies are reviewing their bottom line numbers. Companies are cutting back, reducing expenses, laying off staff and restating projections. One question many sales-oriented companies are asking is "How are sales affecting our bottom line?"
There are many components that affect the net effect of sales to the bottom line: sales, cost of goods sold, receivable balances, bad debt write-offs, variable compensation, direct sales costs and indirect sales costs. The automotive and financial industries have certainly gotten our attention. One of the key points in the recent Wall Street debacle was related to incentive compensation plans and the bonuses paid to key executives. The question in my mind is "Were bonuses really necessary and what did these executives do to receive them?" The affect on the bottom line of these questionable executive compensation packages was catastrophic for a number of financial companies.
How Incentive Compensation Affects Your Bottom Line
Hopefully sales will generate revenue and have a positive effect on your bottom line. But more specifically, what components affect the bottom line and how can you manage them more effectively? Incentive compensation is one such key element and has a direct effect on the bottom line impact of sales revenue.
It is all over the news that in the case of the Wall Street bail out, a number of executives were awarded bonuses but their companies were not in a financially sound position to award those bonuses. What happened? How did these executives 'qualify for their bonuses? Was there a guarantee in their compensation package? I am sure many companies are reviewing their incentive compensation packages, and if they are not, they should be. I would like to review those compensation packages and plans for the executives in the news!
The cost of sales affects the impact of the sales on the bottom line. Is it possible to have sales negatively impact the bottom line? Let's look at some examples of how sales may negatively impact the bottom line.
Case 1: A loan officer sells a loan and the origination fee is 1 percentof the loan value. Let's say that the loan is $300,000, which means that the origination fee is $3,000. If the loan office is compensated at 5 percent of the origination fee, then the commission is $150. But let's say the branch manager decides to give this loan officer a $500 bonus for closing the loan, which brings the compensation up to $650. The branch manager receives a 2 percent override on each loan closed, so that is another $60. This brings total compensation up to $710. This leaves $2,290 available for the bottom line, but this number is affected by administrative costs. Administrative costs may include underwriters, closers, administrative assistance, copies, postage and other costs associated with the loan. Assuming that the other expenses allocation is estimated at 25 percent of the origination fee, then this is $750. This leaves a positive impact for the bottom line of $1,540.
Let's change the scenario a bit, and say that the origination fee is $3,000, but in order to close the loan quickly, the lender gives the borrower a break and only charges $1,500. If the commission is based on the origination fee that should have been collected, then consider the following:
Origination fee collected +$3,000
Commission -$ 150
Bonus -$ 500
Manager override -$ 60
Admin allocation -$ 750
Impact on bottom line $ 1,540
Origination fee collected +$1,500
Commission -$ 150
Bonus -$ 500
Manager override -$ 60
Admin allocation -$ 750
Impact on bottom line $ 40
Compare the impact on the bottom line here-we went from $1,540 to a $40 effect on the bottom line. Incentive compensation can and does affect the bottom line. The wording of a compensation plan, the structure of the compensation plan and the 'under the table' compensation can have an incredible impact to the bottom line.
Case 2: An executive has a compensation plan that is based on sales for the year and he gets paid $1,000,000 per year in salary. He also receives a bonus of up to 200 percent of his salary if the company meets and exceeds their sales goals. If the company has a tremendous sales year and exceeds the sales goal, he has the potential for a $2 million bonus.
But what happens if in this same year, there are large expenses due to a lawsuit and write offs that affect the bottom line? The executive bonus is based on sales, not on the bottom line. He still gets his $2 million but maybe the company is in a net loss status for the year. This $2 million could have a catastrophic effect to the company's viability and throw the company into a position loss that may take a reorganization to salvage.
In this case, the impact of sales may have appeared positive but in the final outcome, sales had a negative impact due to the incentive compensation plans.
Two key points that I wish to make:
- Compensation plans need to be clear, fair and adhered to company-wide.
- Compensation should always be tied to accountability and responsibility.
- A sales representative is accountable and responsible for the sale and cost to close that sale.
- A manager is responsible for the actions of the sales representative, and how sales impact his bottom line and his group's viability.
In a world of post 'Wall Street Failure' and an automotive industry bail out, I have no doubt that there will be new regulations regarding compensation plans. One of the key things I expect to see is a more stringent look at the viability of the organization playing a role in incentive compensation for management, and a stricter reporting policy for any type of incentive compensation plan and possible impacts to the bottom line. I suggest that companies consider that this will be a sensitive audit point in the near future. On Feb. 5, the Wall Street Journal published a number of articles related to the bail out plan and many of these addressed pay limits for executives that are outlined in the new 'bailout' funds plan. It appears that a number of organizations are reviewing their executive compensation plans already with an eye towards protecting stockholders. The question then becomes, how long until this trickles down to all variable compensation plans?
How to determine if Sales are negatively impacting Your Bottom Line
In order to determine if sales are negatively impacting your bottom line and potentially creating a negative sales effect, I suggest organizations perform compensation audits on their own, or bring in consultants to perform an audit.
Some questions to address in the audit of compensation plans:
- Are the plans clearly understood and are they adhered to as expected? Is there any confusion or individual interpretations that need to be addressed?
- In an extrapolated sample, is the impact on the bottom line greater than or less than expected?
- What is the expected impact on the bottom line?
- If the expected impact is greater than or less than expected, then why? Is it due to over payments, under payments, misaligned payments, or confusion over how compensation is calculated?
- Is there accountability for the bottom line for sales managers and management? Is there accountability to the viability of the product or unit or region?
- Who am I compensating for a sale and how am I compensating them? In many cases, there are a number of potential resources involved in any given sale that may receive some compensation for that sale. It is important that these people be compensated, but not to the detriment of the bottom line. Adjust the compensation plans to protect the viability of your organization.
- How do the sales support staff and administrative costs affect the sale?
- Does your compensation analyst have the authority to say 'no' to payments that do not tie to the compensation plans? This is a key policy if you want to be able to clearly tie payments to their source. Can there be an exception policy? A resounding 'yes' here, but with the proper approvals and documentation only. This ensures that there is a clear audit trail, accountability and responsibility for the additional payment.
These are just a sample of the questions to ask during a compensation audit. These will set an organization on the path for determining how sales impact their bottom line and if there are negative impacts. Once this audit is complete, and the organization understands the impact to their bottom line, they can determine policies and procedures to enable them to fix issues and increase the positive impact on the bottom line.
What You Can Do to Improve Your Bottom Line
Many organizations will be asking themselves over the next few months and years, "What can I do to improve my bottom line?" When we talk about sales performance management (SPM), we are talking about compensation management, quota management, territory management, reporting and analytics. There are a number of automated solutions on the market that can assist an organization in all of these areas. With the need to understand and manage the impact of sales on the bottom line, many organizations will need to review their processes and policies. Part of the processes review will trigger the discussion about an automated system or the need to expand on their current system.
Automated solutions provide for the ability to manage data, manage calculations, automate reporting, and in today's world of financial analysis, create a reporting environment that allows for key metric reporting without a long wait. SPM reporting metrics may include reports such as Sales Performance to Quota, Sales Compensation to Total Sales by Region, Sales Compensation to Net Sales by Region, Growth Reporting (sales increase/decrease across periods), and other metric reporting to determine the true effect of sales and compensation on the organizations financial status. A company needs to carefully consider those metrics that will help them determine the true impact of their sales to the bottom line.
Companies must review compensation plans and determine how to compensate personnel fairly, accurately and in such a way that the plans are clear and the intent is understood. The data involved in the calculation needs to be clear and should prevent any 'personal' interpretations from taking precedence over the corporate intent and interpretation. If there are a number of personal interpretations that are currently driving compensation, then the organization should review these and start a process of moving everyone to a 'global' interpretation. The company may also make a determination to compensate on margin instead of sales based numbers.
The SPM process should allow for some flexibility, but there also needs to be a clear process for exception, and the compensation analyst should have the ability to say 'no' to anything outside of the compensation plan or question part of a compensation plan that is not handled as part of this exception process.
I believe that variable compensation will affect the viability of many companies in the future. These companies will review their compensation packages for their executives, management and sales force to determine the impact not only on the income statement and balance sheet, but the overall company bottom line. I think a key component that may very well affect sales executives in the future will be outstanding receivables for sales related activities, as well as write offs of sales that may not be currently affecting them.
A company will need to invest in an automated SPM process that gives them transparency into sales data, compensation related to sales, management activities in sales processes and processing, as well as reporting of key metrics that will allow management to clearly determine the impacts of sales activities to the viability of the company.
Susan Major is a management consultant of the Sales Performance Management (SPM) practice at Revelwood, a technology solutions provider for IBM Cognos and Varicent. She can be reached at firstname.lastname@example.org or (817) 688.7251.