Considering Sharing Profits? Things to Consider

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Profit sharing is a payment plan in which an organization’s leadership decides to share a certain percentage of the company’s annual profits with its employees. The profits can be paid directly in cash or in company-issued stocks and bonds. A company’s formula of profit distribution can include all employees or just with specific positions, such as managers and executives.

 

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Creating profit sharing at your company

When a company decides to create a profit sharing plan, two major steps need to be taken:

 

  1. Deciding the amount of money that will be paid out to employees: First of all, this implies that the company is generating a profit. Companies typically decide on a percentage of the total profit that will be used for profit sharing. This keeps employees motivated because a bigger company profit automatically suggests a larger amount of money to be distributed.
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  3. Deciding which employees will be benefiting from sharing the profits: Companies typically distribute the shared profit either equally among employees as a percentage of their salaries, or based on the contribution that each of them had in the company’s success.

Choosing the right amount of money and method of distribution varies among companies, with the ultimate purpose to increase productivity through motivation. This typically signifies strong communication between the company’s management and the rest of the employees, as they need to properly understand the benefits they can receive from profit sharing.

 

Related: How to Grow Your Business

 

The purpose of profit sharing

Here are some of the benefits of properly implementing a profit sharing plan:

 

  • Increased employee productivity: This is usually the main purpose of sharing a company’s profits with employees. Knowing that working harder is very likely to increase their revenue is typically an effective incentive and will result in higher productivity, as opposed to the employees receiving a fixed paycheck regardless of the quality of their work. 
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  • Employee loyalty: A company that shares some of its profits with its employees is more likely to increase worker loyalty. Employees with incomes that are directly proportional to the organization’s profit generally become more invested in its future success, as they get the sense that they are part-owners of the company. This makes them more likely to stay with the company for a longer time, as they feel they have more control over their financial future.
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  • Tax reductions: A company can also share profits with its employees through a 401(k) profit sharing plan. This implies the respective company making contributions to their employees’ 401(k) accounts based on its profits. These contributions count as tax deductions and won’t be taxed until the employee uses them upon retirement. This will likely also work as a motivational tool for employees, as their work has a direct impact on their retirement savings.
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  • Costs proportional to profits: Sharing profits with the employees are also generally beneficial for the organization when the profits are low, as the amount of money that needs to be shared with employees decreases proportionally. This makes it an effective tool for small businesses, as they will have lower payments and 401(k) contributions in times when the company is not generating much profit or no profit at all.
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  • Employees as consumers: A small business has a significant chance of getting back some of the financial contributions paid to employees, as they will have more money and be more likely to become customers. Depending on the goods or services the company is selling, there is a good chance that employees will stay loyal to the organization when they will need those respective goods or services.

Related: How to Reduce Employee Turnover

 

Profit Sharing FAQs

Here are some Frequently Asked Questions regarding profit sharing:

How can you calculate profit sharing?

There are several ways to calculate profit sharing. Here are some of the most common methods:

 

  • Comp-to-comp: This is the easiest way to calculate each employee’s share of the profits, as it gives employees a contribution that is proportional to their pay. To calculate, divide each employee’s salary by the total salary pool. You will be getting a percentage for each, which can be used to determine the percentage of profit sharing that each employee is entitled to.
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  • Pro-rata: This method implies each employee is receiving a profit share that is equal to a fixed percentage of their fixed pay. This is also easy to calculate, as it requires you to determine only the correct percentage, which then will be applied to all eligible employees.
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  • Integration: This is typically used to reward higher-income employees higher shares of the profit when compared to lower-income employees. You can share a certain amount of profits with all employees and also determine an integration level, which is a certain percentage of each employee’s taxable wage. You can then award higher bonuses for employees who earn more than the integration level.
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  • Uniform points allocation: Some employers prefer to share the profits by using certain point values for their employees, usually for criteria such as age and seniority within the company. This way, employees that are older and/or have been with the company for a longer time will be entitled to a larger share of the profits. This can act as a further motivational tool to keep valuable employees working for the organization for longer periods of time.

 

When should your business consider profit sharing?

A company usually decides to share its profits only after it has shown a profit for a specific period of time or as part of salary negotiations for a senior employee. Although most companies calculate the profits they will share after calculating annual income and profit, some organizations prefer to pay a share of profits to employees on a quarterly basis. This makes it more likely that those receiving the profit shares are continually motivated throughout the year.

 

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