What is the compensation plan that combines wage or salary with an additional amount based on the employees performance?

How Does Profit Sharing Work?

Oftentimes, an employer will combine profit sharing with an employer-sponsored retirement plan to allow workers to save even more for their future. However, not all businesses fully understand profit sharing. So, what is profit sharing and how does it work exactly?

Rewarding Employees for Company Performance

Profit sharing is an incentivized compensation plan that gives employees a certain percentage of a company’s profits. Employees receive an amount based on the business’s earnings over a specified period of time, typically once per year. Profit sharing differs from employee bonuses, which are usually given when a company sees a profit. While there are both pros and cons to profit-sharing plans, profit sharing can be an excellent way for employers to reward employees for their great performance.

Advantages of Profit-Sharing Plans

Profit-sharing plans can deliver a wide range of perks, starting with tax benefits. A 401(k)-profit sharing plan contribution counts as a tax deduction for local businesses. In addition, any financial contributions made to these plans are not taxed until the funds are distributed at retirement. This allows businesses to minimize their tax liability and increase their savings.

Employers also do not have to worry about paying their employees in years when profits may be low. As profit sharing programs do not have fixed costs, the expenses that a company incurs will rise and fall based on the business’s annual revenue. This means that if your business has a less profitable year, the contribution to your employees’ 401(k) plans will simply be lower that year. If you make a larger profit the next year, it will then rise again.

One of the most significant benefits of profit-sharing plans is the increase in worker loyalty. When you choose to share your company’s earnings with your employees, it gives your workers a sense that they are part of the company. When employees feel like they are an important part of the business, they will often become more invested, which boosts morale and overall productivity.

Setting Profit-Sharing Levels

Requirements for Profit-Sharing Plans

Profit-sharing plans are available for businesses of all sizes and in all industries. Businesses that already offer other types of employee retirement plans can also take advantage of the benefits of profit sharing. However, profit-sharing plans do come with certain requirements. As of 2020, a company’s contribution limit for sharing its profits with an employee is less than 25 percent of the employee’s compensation or $57,000. The total amount of a worker’s salary that can be considered for profit sharing is limited to $285,000 in 2020.

Before a profit-sharing plan can be implemented, a business must first complete Internal Revenue Service Form 5500. When completing this document, an employer must disclose all participants in the plan. Just like a typical 401(k) retirement plan, an employer will have full discretion as to when and how contributions are made. However, an employer must also prove that a profit-sharing plan does not discriminate against certain people or favor some employees, such as highly-compensated workers.

Contact JMG to Set Up a Profit-Sharing Plan

While profit-sharing plans can be highly advantageous, they are not right for everyone. It is important to determine whether or not profit sharing would benefit your business and its employees. For more information about profit sharing and how it works, reach out to the experts at John M Glover.

Written by David Marshall | Feb 24, 2021 3:39:43 AM

We get asked about OTE all the time. It doesn’t matter if you call it on-target earnings, on-track earnings, or even on-target incentive, OTE is the expected total pay from a job that combines your base salary and the expected amount you’ll earn from your commission.

What exactly is OTE?

OTE refers to on-target earnings or on-track earnings. One’s OTE is essentially the base salary a sales rep can expect to earn if they manage to achieve 100% of their designated quota. This number is usually an annual quota or figure, as opposed to a monthly or weekly number.

This is still a bit vague, so let’s consider an example. Let’s say that a potential sales rep has stumbled upon a sales role job description that details how much money potential sales reps can earn. This job description would say something like “$85,000 OTE.”

That means that the on-target earnings are approximately $85,000, though this number can sometimes end up being larger. That $85,000 is the total compensation someone in that sales position can earn in a year, assuming that they hit 100% of their sales quota for that year.

What does OTE mean for your income?

OTE doesn’t tell you exactly what you’re going to be earning with a job. It’s a way of letting potential hires know approximately how much they can expect to earn if they hit their targets.

OTE helps paint a clear picture of what your compensation package should look like, which can be problematic with sales because there are often quite a few variables that come into play, like whether or not you hit your targets. Learn more about the 7 Steps to Develop an Effective Sales Compensation Plan.

Frequently Asked Questions about On Track Earnings

What does OTE mean for sales commissions?

When it comes to sales, OTE should be considered the possible (and achievable) project commission that a sales representative can earn on a yearly basis if they manage to hit all of their sales targets. This commission is then added to the sales rep’s base salary.

OTE can include salaries earned for a number of things, from typical work hours to commissions to shift loadings to allowances.

Does OTE include overtime?

On-target earnings do not include overtime in most sales scenarios.

What is “Fully-Ramped OTE”?

In many sales commission scenarios, reps will need some additional ramp time. OTE doesn’t often take ramp quotas and ramp payouts into consideration. It’s considered good practice for sales organizations to offer sales reps a draw or pump up their overall commission rate to compensate for low quotas.

What are the benefits of on-target earnings?

OTE is used to properly compensate or reward sales reps for their work in hitting their quotas. One of the biggest benefits of OTE, however, is increasing employee engagement, motivation, and participation. A good sales commission OTE that is easily achievable can create brand ambassadors and long-term employees. If your organization is struggling to improve productivity, establishing a new OTE could make a substantial change.

What issues do recruiters and administrators in sales commissions struggle with when it comes to OTE?

There are indeed disparities when calculating OTE that even large enterprises struggle with. Typically, there are two points during the hiring process in which issues with OTE arise.

• The hiring firm wants to write up the compensation range based on a specification, but they also want their OTE to look very high to attract experienced and proven talent.
• Once a sales rep is placed and the recruiter has been paid their fee, the firm will then become a little less enthused about the OTE that was initially discussed with the candidate.

At this point, the OTE number becomes more of an optimistic number, rather than a probable best-case scenario. The best way to avoid this is to ensure that the OTE is the one and the only number that is used to determine target compensation. That number is going to be what a new sales rep expects to earn if they reach 100% of their quota on a yearly basis and that number should reflect the truth of their compensation. Otherwise, you can expect a high turnover rate and the loss of good sales reps once the truth comes out.

Realistically, the best solution to keeping good reps that churn out quotas with gusto is to keep your company’s OTE simple and honest. Ensure that it is the only number that your potential hires understand and can agree to, and try to base it as closely as possible on the candidate’s established earnings via their W2 paperwork. On top of that, sprinkle some built-in growth to make your offer more attractive than your competitor’s. Your sales department is only as strong as your reps!

How OTE gets calculated

In its simplest form, OTE is calculated by adding together your base salary and on-target commissions. This means that if your base salary is $75,000 and your on-target commission is $35,000, your OTE would be $110,000 if you hit all your sales goals.

Calculating OTE gets a bit easier if you refer to this formula:

Yearly base salary + Yearly commission earned at 100% of quota = On-Target Earnings (OTE)

Calculating OTE gets more complicated when you start looking at all the different combinations of how you break down OTE, like monthly payments, quarterly, or semesterly. You also need to consider how this can be sliced across those different time periods. You also need to take true-ups into accounts.

To help you gain a deeper understanding of what those calculations look like, check out the video at the end of this post. We break down the process for calculating the various permutations of OTE.

Remember that OTE is never guaranteed

When it comes to sales commissions, OTE is almost never guaranteed. This is important to understand both as a Sales Comp administrator (or hiring manager) and as an aspiring sales rep.

During the interview process, hiring managers should be transparent about average attainment. If a role’s on target earnings is an impressive $150,000, that number doesn’t mean much if the average attainment is only 45% of quota for that role.

In this case, the average total compensation is quite a bit lower. OTE should not be impossible to reach and sales commission teams will work much more efficiently if that number is possible.

Other aspects of calculating OTE

On Track, Earnings can also be calculated as fixed payments, special commission percentages, or some mix of both. For Sales Comp administrators and stakeholders who want to determine the best course of action for a sales rep role’s OTE, there are a few general guidelines to consider.

To start, it is usually a good idea to base the on-target earnings OTE on approximately a fifth of the total annual quota. It can also be a good course of action to base sales commission role’s OTE on around six to seven times the total sales quota. Calculating OTE depends quite a bit on your unique industry, how experienced your sales representatives are, your management teams, your unique sales process, revenue, sales role popularity, and much more.

When it comes down to it, a business’s OTE for sales commissions should be agreeable for all parties involved. It can be based on a potential rep’s established earnings, but it’s also important for administrators to allow for some growth to capture the interest of potentially high-earning candidates.

In that same vein, it’s also important to make sure your sales commissions OTE isn’t inflated either. It’s very unethical to pump up that number while hiring a potential candidate and then knocking it down once the sales rep begins working on commissions.

The purpose of OTE is to motivate your employees and properly compensate them for the hard work they have done. An attractive OTE that has a high achievement rate will also entice sales reps to stick around for longer.

Let’s talk about Pay Mix

You can’t really discuss OTE without talking about Pay Mix. Pay Mix is the ratio of base salary to commission and is what helps determine the OTE for a role. If your pay mix is 75/25, then your base salary is 75% of the mix, and the commission is 25%.

There are a bunch of factors that determine what the pay mix is. This includes things like what the role is, how motivated you want your sales team to be, and even the kinds of people you want to attract to your company.

For example, a pay mix of 0/100 is going to be a role that is totally focused on commission. It’s going to be something that appeals to some people, but not everyone. There is a high amount of uncertainty with a mix like that.

The best way to determine what the ideal mix is, look at the following:

Prominence of the sales role

High-risk roles like account executive or new business executives are often more directly responsible for signing new business. The mix needs to be more heavily weighted on commissions to encourage a more aggressive approach.

Sales cycle length

If you’re a company with a shorter sales cycle, a lower mix is okay because the sales team will be closing more deals in any given period of time. However, for longer sales cycles, the payout needs to be high enough to motivate salespeople to stick with it.

Complexity of products, services

The more complex your offering is, the more likely it is you’re going to want someone who really knows your industry, you know, an expert. This level of experience often comes with a higher price tag (as it should), so you need a higher base salary.

As a general rule, a pay mix of 50/50 is a good starting point. It’s a common mix and provides a good balance between base rate and commission.

How to manage On-Target Earnings Plans

Performio has been designed to help Sales Comp administrators easily manage OTE plans. The video walks through definitions and examples of how OTE plans work and finishes with how Performio makes it possible to set up any of these plan permutations out of the box in minutes using the pre-built Target and Payable components.

Get the Most Out of Your On-Target Earnings Model with Sales Commission Software

Since Performio’s humble beginnings, our team has worked diligently to save ove a million administrative hours and calculate over $2 billion in commissions.

Our sales commission software is a top-tier tool designed to help businesses automate their sales compensation processes and create a more efficient and cohesive sales environment. Many businesses want to increase transparency in their sales compensation calculations to help their sales representatives do what they do best-- and Performio is here to help.

If your business is interested in enterprise-level functionality and increases sales transparency that large businesses like Johnson & Johnson and Vodafone enjoy, get in touch with the team at Performio today to get started!

On-Target Earning FAQs

What does OTE mean?

On-Target Earnings (or just Target Earnings) refers to the amount paid to a payee if all their targets have been achieved. A salesperson’s compensation earnings are constituted of base salary and the additional variable components in a compensation plan like bonuses and commission.