The financial test provides sales rep contribution data that is a reflection of how well the size of the sales force is sized against market opportunity. The financial test is particularly insightful when you can assess historical data and perform the test year over year the past five years. Many companies made cuts to their sales staff the past 2-3 years and by comparing the contribution rate of a sales rep before and after the cuts you can certainly gauge effectiveness, and more importantly get insights into the degree to which the sales staff is sized. A dramatic increase in the contribution rate certainly indicates a leaner, stronger team but also reveals the high potential of a sales force that is undersized where reps are able to focus on low hanging fruit or maybe even “white elephant hunting” large profitable deals bypassing harder gained mid-sized deals.
Part I: Estimate the annual cost of a sales person
1. Calculate total annual sales staff compensation including total salary, commission and bonus amounts
2. Determine value of benefits
3. Determine Administrative and field support costs
4. Determine annual T&E, travel, auto, phone, laptop costs for the sales people
5. Establish the total cost of a sales person by summing costs from points (1-4) and adjusting for number of sales people
Number of Sales People = 10
Total Salary and Incentive pay for sales representatives $1,500,000 Benefits value $ 150,000 Administrative and Field Support $ 600,000 Annual T&E, auto, phone, laptop costs $ 200,000 Total costs $2,450,000
Total costs of $2,450,000 divided by 10 sales people = $245,000 annual cost of a sales person
Part 2: Estimate the gross contribution margin
1. Determine variable product costs (all costs that vary with how much product is sold)
2. Determine total annual sales
3. Subtract variable product costs from total sales to establish the gross contribution
4. Divide gross contribution by total sales to determine gross contribution margin
Variable Product Costs $9.0M Total Annual Sales $27M Gross Contribution $18M Gross Contribution Rate $18M/$27M = 67%
Part 3: Calculate break-even sales
1. Divide the cost of a sales person by the contribution margin rate
$245,000 cost of a sales person divided by 67% contribution margin rate = $365,671.60
Part 4: Calculate average annual sales per sales person
1. Divide total annual sales by total number of sales people
Number of Sales People 10 Total Annual Sales $27M
$27M annual sales divided by 10 sales people = $2.7M
Part 5: Compare break-even sales with the average sales per sales person.
Compute the Average Sales/Break-even Sales Ratio
1. Divide average annual sales per sales person by the break-even sales amount
Average annual per sales person $2.7M Break-even sales amount $365,671.60
Average Sales / Break-even Sales Ratio for a sales person is $2.7M divided by $365,671.50 = 7.38. In this example case, a sales person generates gross margin of 7.38 times their annual costs to the company indicating the likelihood that the sales force is undersized.
Don’t leave money on the table with a sales force that is too small and the financial test provides a data point and also aids you in understanding the expected contribution rate and breakeven of additional sales reps. World class sales forces optimize their sales force for maximum revenue and the financial test is a key part of your analysis.