There are some industries like pharmaceutical sales or furniture sales where sales commissions are the primary mode of compensation. Base salary is usually small or non-existent in these sales verticals, hence, the sales reps rely mainly on commissions.
How do they pay their bills then? That is the question we are here to answer.
To solve this problem, the concept of draws is used. Commission draws are advances extended to salespersons at the beginning of a month to help them have financial stability. These are interest-free advances, so the salespersons do not incur any costs for this benefit. They have to return this advance when their commission earnings for the month are finalized.
Commission draws are useful when there are long sales cycles, inconsistent commission earnings, and commissions are the dominant compensation method.
Suppose a salesman has been given a $4000 commission draw at the start of the month and he makes $6000 in sales commissions that month. He will then receive $2000 ($6000-$4000) at the end of that month as his commission paycheck since he already received $4000 at the start of the month as an advance (draw).
This guide will explain recoverable and non-recoverable draws, the two types of commission draws used extensively.
What is a Recoverable Draw?
A recoverable draw is an advance commission payment extended to a salesperson for which they are liable to repay any shortfall if actual commissions earned are lower than the draw.
For example, if an amount of $3000 is given as a recoverable draw, and the salesperson only makes $2000 in sales commissions that month, then they are liable to repay the shortfall ($1000), which is usually deducted from the future months' commission earnings whenever the salesperson is in a surplus. The shortfall is carried over as debt (interest-free) until it can be paid back through commission earnings.
If the salesperson exceeds the draw amount in sales commissions, the excess is credited to them normally and they are not supposed to repay anything. For example, if a recoverable draw of $3000 is extended at the start of the month, and the salesperson makes $5000 in sales commissions that month, they are credited the $2000 excess they have made at the end of the month.
Recoverable draws give financial stability by providing guaranteed income to the salespeople while also ensuring that the company does not pay any unearned commissions, since any shortfall from the draw amount is liable to be repaid by the salesperson.
What is a Non-Recoverable Draw?
Non-recoverable draws are also advances paid against commissions earned by salespersons, but the salespersons are not responsible for paying any shortfalls in commissions earned as compared to the draw. For example, if a non-recoverable of $3000 is extended at the beginning of a month, and a salesperson only makes $2000 in sales commissions that month, then they can simply write off the $1000 shortfall and they are not supposed to repay it.
Again, if the salesperson exceeds the draw amount, they can simply keep the excess after returning the draw amount. So if a salesperson with a $3000 non-recoverable draw makes $5000 in sales commission in the same month, they can keep the $2000 excess after paying off the draw.
In the case of non-recoverable draws, the company ends up incurring the cost of any shortfalls in commissions earned, since they have to pay out the non-recoverable draw even if a salesperson cannot pay it back fully. The shortfall is not carried over as debt and is not deducted from future earnings, as in the case with recoverable draws.
Note: Commission draws are simply interest-free advances against sales commissions. They are deducted from total commissions earned at the end of the period, and only the excess (if any) is paid out. Any shortfall (i.e. draw is higher than earned commissions) is ignored in the case of non-recoverable draws and is carried over as debt in the case of recoverable draws.
Recoverable vs. Non-Recoverable Draws
Illustrations of Recoverable and Non-Recoverable Draws
Recoverable Draw
Example 1: Crossing Draw (Excess Commission)
Draw Structure:
Draw amount: $3,000 paid on June 1
Commission rate: 10% of sales
Commission calculation: End of June
Scenario:
June 1: Sales rep receives $3,000 draw
June 30: Sales rep's final sales total: $45,000
Earned commission: $45,000 × 10% = $4,500
Since earned commission ($4,500) exceeds the draw ($3,000), the rep receives excess of $1,500 on June 30
Total compensation: $3,000 (draw) + $1,500 (excess) = $4,500
Example 2: Falling Short (Draw Exceeds Commission)
Draw Structure:
Draw amount: $3,000 paid on July 1
Commission rate: 10% of sales
Commission calculation: End of July
Scenario:
July 1: Sales rep receives $3,000 draw
July 31: Sales rep's final sales total: $25,000
Earned commission: $25,000 × 10% = $2,500
Since earned commission ($2,500) is less than the draw ($3,000), the rep owes $500
This $500 deficit is carried forward to next month's commission calculation
Total compensation: $3,000 (draw), with $500 debt carried forward
Non-Recoverable Draw Examples
Example 1: Crossing Draw (Excess Commission)
Draw Structure:
Draw amount: $2,500 paid on August 1
Commission rate: 8% of sales
Commission calculation: End of August
Scenario:
August 1: Sales rep receives $2,500 draw
August 31: Sales rep's final sales total: $40,000
Earned commission: $40,000 × 8% = $3,200
Since the earned commission ($3,200) exceeds the draw ($2,500), the rep receives excess of $700 on August 31
Total compensation: $2,500 (draw) + $700 (excess) = $3,200
Example 2: Falling Short (Draw Exceeds Commission)
Draw Structure:
Draw amount: $2,500 paid on September 1
Commission rate: 8% of sales
Commission calculation: End of September
Scenario:
September 1: Sales rep receives $2,500 draw
September 30: Sales rep's final sales total: $25,000
Earned commission: $25,000 × 8% = $2,000
Since the earned commission ($2,000) is less than the draw ($2,500), there's a $500 shortfall
With a non-recoverable draw, this $500 deficit is forgiven and not carried forward
Total compensation: $2,500 (draw), with no debt carried forward
Wrapping Up
Sales compensation is complex and time-consuming since it has to ensure the sales reps can deliver maximum sales performance, while the organization can still effectively manage costs. Sales commission draws work great for this purpose since they guarantee a minimum income at the start of a period but are just advances against commissions that will have to be paid anyway, so there are no extra costs (except in the case of shortfalls in non-recoverable draws).
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FAQs
Do you have to pay back the recoverable draw?
Yes, any shortfall in earned commissions compared to the given recoverable draw has to be paid back in future periods when the commissions earned exceed the draw amount for that month. If there is no shortfall (commissions earned > recoverable draw) then nothing has to be repaid and the excess (commissions earned - recoverable draw) is credited to the salesperson.
What is a recoverable draw example?
A recoverable draw is an advance paid out to sales reps against their commissions. If they aren't able to earn commissions to cover the entire draw, they have to pay back the recoverable draw in future periods when they exceed the recoverable draw.
Is a non-recoverable draw good?
Non-recoverable draws ensure salespersons make at least a minimum amount to help them manage their expenses. Even if they can't cover the entire draw in commission earnings, no debt is created in the case of non-recoverable draws, so they are more employee-friendly, and hence preferred by sales reps.
Does a draw have to be paid back?
A draw is an advance against commissions, so it doesn't have to be paid back if sales reps earn commissions to cover the entire draw. The only case where draws have to be paid back is when a sales rep has been given a recoverable draw and cannot make commissions as much as the draw.
Is a recoverable draw taxable income?
Yes, a recoverable draw is treated as taxable income since it is part of an employee's sales compensation plan.
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