Jack Stack, the renowned author of ‘The Great Game of Business says, “By profit sharing, I mean the practice of taking a percentage of a company’s profits, putting it into a pool, and disbursing it to the company’s employees, usually sometime after the close of the year. Understand, I’m not saying that this is a bad thing to do, just that the benefits of doing it are limited. For openers, the recipients seldom know exactly how they helped generate the profits beyond just doing their jobs. No doubt, they enjoy getting the money. They may even be grateful for it. But they aren’t likely to think or act differently because of it or to be greatly motivated by it.
What’s more, if they keep getting it, they will eventually come to expect it, depending on it. If they don’t know what they’ve done to deserve the extra money, they will begin to view it as part of their regular compensation–that is, as an entitlement program. At that point, the profit-sharing check is a bonus in name only, no matter how much the amount may vary yearly. Meanwhile, you’re getting results opposite of what you’re paying for. You’re promoting the same attitudes you had hoped to change by moving to variable pay in the first place.
What is Profit Sharing?
Employees participating in profit-sharing programs receive a portion of the company’s profits before taxes.
To put it simply, profit-sharing is a method of giving your staff a share of your company’s profits. Along with their income and bonuses, an employer can pay it directly or indirectly. It is based on the compensation package offered to the employee as well as the overall income produced by the business. The amount of money the firm will annually contribute to an employee’s plan can vary.
Similarly, a Profit-Sharing Plan is a retirement plan that allows employees to participate in the company’s profits. An employee is given a portion of a company’s profits under this kind of plan, also known as a Deferred Profit-Sharing Plan (DPSP), based on its quarterly or yearly results. This is a fantastic method for a firm to instil a sense of corporate citizenship in its workers. Still, there are usually limitations on when and how to withdraw these monies without incurring fees.
Businesses choose how much they wish to distribute to each employee by setting up profit-sharing agreements. When a corporation offers a Profit-Sharing Plan, it modifies it as necessary, occasionally contributing nothing. The business must devise a predetermined method for profit allocation in the years when it makes contributions.
Difference Between Employee Bonus and Profit Sharing
Businesses choose how much they wish to distribute to each employee by setting up Profit-Sharing agreements. When a corporation offers a Profit-Sharing plan, it modifies it as necessary, occasionally contributing nothing. The business must devise a predetermined method for profit allocation nevertheless. This is why both businesses and employees need to understand the difference.
In a profit-sharing agreement, an employer and employee agree that the employer will split some of its profits with the employee. The main distinction between a bonus and profit sharing is that before any of the profits are distributed to the employee, there must first be a profit.
Employees participating in profit sharing plans may get cash, stocks, or bonds as compensation (cash profit sharing plan). Profit-sharing benefits are paid out as part of an employee’s retirement plan (Deferred Profit Sharing Plan) and may be tax-deductible depending on the retirement plan. Benefits are paid out upon retirement rather than upfront.
Bonuses are payments made to employees in addition to salaries or wages as compensation for work completed. Business owners frequently award bonuses without any formal plan, unbiased procedure, or even a clear path for how the bonus might be obtained. Bonuses can be awarded at any time of the year. However, they are frequently given out during the holidays. Bonuses are frequently used and are a good way to acknowledge exceptional performance or efforts by specific employees. The bonus amount is usually left up to the employer’s discretion. Still, it may be determined by some predetermined formula where the employee receives a specific portion of the actual savings.
Types of Profit Sharing Examples & Plans
Profit-Sharing Plans are primarily divided into three categories:
Plan of Deferred Profit-Sharing
In a Deferred Profit-Sharing Plan, the withdrawal deadline is postponed to a later date, such as retirement, death, or job termination. The company also establishes a lock-in period during which the employee is not permitted to withdraw funds. Consequently, putting such a plan into action increases staff retention.
Dual Profit-Sharing Scheme
The combination of the two aforementioned types of plans, as the name implies, offers employees the best of both worlds. Their retirement plan receives a share of the profit, and the remaining sum is cashed. They can reduce certain taxes as a result and feel immediate gratitude for the company.
Present Profit-Sharing Strategy
The employer decides how to distribute the compensation in this kind of profit-sharing arrangement. Cash or stocks are both acceptable forms of it. Typically, it takes place once a year or as needed. One of its advantages is that it gives workers immediate recognition for their efforts to the business. Additionally, it gives them a recency effect that inspires workers. The drawback of this profit-sharing arrangement is that the entire sum is taxable as normal income.
Is Profit-Sharing a Bonus in Name Only?
Profit-Sharing Plans can cause discontentment among some workers. It seems unfair when somebody gets a higher share when everyone puts in the same effort. Similarly, suppose everybody gets an equal share. In that case, it can be unfair to those who do the bare minimum and get equally paid.
On the flip side of Profit Sharing, receiving a bonus solely depends on the company, its profits, your share of the profit, and the type of Profit-Sharing Plan. All of these are contributing factors to the bonus an employee receives, but there are some things one should keep in mind regardless:
- Individual employees’ earnings increase evenly, regardless of their performance or chances for advancement.
- Smaller businesses may find that the company’s dramatic earnings changes impact the employees’ personal profits.
- The employee can be more concerned with profit than with quality.
- The will to work hard to increase the company’s profit wanes over time and employees begin to view it as a right.
- Regardless of their participation, everyone receives a portion of the earnings.
- Because they receive a larger portion of the profit share, top-level employees are more motivated than those in lower positions.
You must be open and honest about business finances to establish a profit-sharing scheme. You are not required to disclose your turnover or gross profit. However, you must be open and honest about some of the final figures. Additionally, your business must be earning consistent profits. People occasionally receive significant profit shares, which raises their expectations. Sometimes the profit share is so small that they are completely uninterested. To keep them motivated, it would be excellent if you could strike a good balance.
- Is profit-sharing considered a bonus?
Some companies sometimes distribute the profit-sharing payment in cash. Then it is regarded as a bonus and subject to regular income tax.
- How is the profit-sharing ratio determined?
- Divide the total payment by the salaries of all the employees.
- Add the profit percentage to the overall profits for that year.
- To calculate the profit share for each employee, multiply the two results.
- Which is preferable, profit-sharing or equity?
Equity is preferable for fledgling enterprises that require quick money to get going. For established businesses that need to recruit and keep people, profit-sharing works best.