Money, as we all know, is a great motivator, and if an employee is offered a chance of owning a part of profits, it takes his motivation and contribution to the next level. Profit-sharing is defined as a process where a business entity offers its employees a benefit to instil ownership in them. Profit-Sharing refers to the incentive plan that provides indirect or direct payment to the workforce and is dependent on the profitability of the business entity.
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Meaning of profit sharing
Profit-sharing is a process wherein you share the profits with your key employees and is often described as a form of additional remuneration to keep the employees engaged and satisfied in the job so that the rate of employee retention is higher. The share allocation is in addition to the standard wages or salary that an employee receives and is not based on output or time.
It is a general belief that profit sharing will make the employees work harder as they have a share in the profits. It is a fact that a business entity that decides to implement the scheme of profit sharing will choose amongst its key stakeholders the sharing allocation and the percentage of profits they are willing to share and distribute so that there is no confusion later on. It is then that profit sharing is paid out as a percentage on the annual salary of the employee.
A profit-sharing plan must be in writing so that all the pertaining rules and regulations can be laid out explicitly. The payments are made on an annual basis after the year-end reports and the profits are calculated. In most cases, restrictions are placed so that the access to funds is not so easy. The employee might have to wait a specific time duration before he can withdraw any amount from the profit-sharing funds.
The conventional profit-sharing methods are
- Cash money
- Mutual funds
- Stocks or company shares
Profits to the employees as per the profit-sharing process can also be distributed based on
- The excellent performance record of an employee
- Attendance of every employee working in the company
- Merit rating of the workers
- A fixed percentage of the total wages that are already agreed upon beforehand for a definite period
- No of years of employment in the company
The objectives of profit-sharing are as follows-
- Raising the productivity of the workforce
- Attract desirable and competent employees in the company
- Boosting the efficiency of the employees
- Encouraging the feeling of responsibility in an employee
- Develop the attitude and habit of waste elimination and scrap reduction amongst the workers
- To align the interest of the employee with those of the employer
- Encourage and develop a better understanding between the employees and management so that sorting out issues in an amicable manner becomes possible.
- Reduce employee turnover and rate of absenteeism in the organization
- Bring about a spirit of cooperation and teamwork amongst the employees
- Encourage a proprietary attitude in the employees
- Boost employee morale
- Minimize administrative issues
- Ensure job security
- Encourage industrial democracy and harmony by developing good relations between the workforce and the management
- Encourage equitable distribution of wealth and social justice
The characteristics of profit-sharing are as follows-
- As per the rules only profit is shared under this scheme and not losses
- Profit-sharing is not a wage/salary payment; instead, it is an additional remuneration
- The share allocation of profits is dependent upon the profits of a company
- An essential characteristic of profit sharing is that the proportion of profits that is to be shared amongst the employees is predetermined and mutually agreed and accepted so that there is no scope for misinterpretation, alteration or changes in the agreement
- The profit-sharing scheme is generally applicable to all the employees but subjected to certain norms
- The profit-sharing plan is a voluntary arrangement and is decided after the joint consultation of representatives of employees and employers.
- The mode of payment is usually cash and sometimes also includes company shares, bonds, stocks, and mutual funds
- The amount to be distributed as part of profit-sharing is based on a set formula that is to be applied in all circumstances.
Features of profit sharing
The Features of profit-sharing are as follows-
- It is a voluntary agreement and is made freely without any undue pressure
- The employee should satisfy the minimum condition or requirement, which is to be determined by the management.
- The payment may be in cash or stock of future credit, which is above the regular payments that would have been given to the employee in a specific situation
- The profit-sharing agreement is a binding agreement that has been mutually decided upon and accepted. There is no loophole where the employer can make changes as per his wishes
- The amount of profit-sharing is to be computed based on an agreed formula and should be applied in all situations
- The profit-sharing amount depends on the profits shown by the company
- The profit proportion is predetermined
Advantages of profit sharing
The advantages of profit-sharing are as follows-
- A healthy relationship between employer and employee – when an employer is willing to share profits with his employees, it shows a willingness on his part to take every employee with himself in this journey. It is a voluntary act and promotes healthy employer and employee relationship. When the employee becomes invested in the company, there is a feeling of ownership that encourages a solid bond and leads to lack of absenteeism and a lower rate of employee turnover
- Additional income for employees – The employees become involved in the business entity 100% because they realise that the revenues earned will be eventually also distributed amongst the workforce. This is additional income for then which they can receive besides their regular wages/salary. Every extra penny is an earnings for the employee that can prove a blessing during later years
- Increase in productivity – The employees realize that until and unless they increase their efficiency levels, the productivity will not rise and this will have a direct impact on the profit of the business. This is why employees will try to accomplish their tasks more effectively
- Less supervision – As the workforce is in itself interested in the growth and development of an organization, they do not need as much supervision as their counterparts in other companies. Even without someone keeping a constant eye on them, their track record for accomplishing tasks is much better.
- Reduced employee turnover- The profit-sharing allocation plan is loosely based on the length of the service of an employee in an organization. To be eligible for this scheme, an employee has to work for a minimum period that is specific and is for a long duration. This is why companies that have a policy of profit-sharing have reduced employee turnover and increased employee retention rates because the employees do not want to lose the incentives for which they will be eligible.
- Social justice – A profit-sharing organization believes in the equitable distribution of wealth and by implementing such a scheme, they tend to set up high standards in the world. This fosters equity and social justice among other firms
- Boost in team spirit – Every team member has something to gain if there is an increase in profits. This is why every one of them tries to help each other out in difficulties and make strong bonding. They all know that if the work stops for any reason, that means a reduction in profits and ultimately their share. Thus profit sharing has a direct impact on the team spirit in an organization
The disadvantages of profit-sharing are as follows-
- In the case of loss, no bonus – A profit-sharing plan is viable as long as a company is earning profits. If there are no profits, it means no incentive or bonus
- A disadvantage for a new firm – If a new firm implements the concept of profit-sharing it means additional expenses and lack of proper support in the initial days that can prove harmful as it will take it much longer to find its footing
- Deliberate profit mismanagement – Some companies implement the concept of profit-sharing at the onset to grab all its advantages like employee retention and increased efficiency and productivity. When the management later realize the amount that will have to be shed as part of the allocation scheme, they might suppress the profits by deliberately mishandling the books
- The element of uncertainty – There is always an element of uncertainty in earnings. Sometimes everything goes as per the plan, and even then, the company is unable to achieve the required amount that they could eventually distribute among the employees as part of profit sharing allocation. This results in the loss of employee’s trust and proves severe limitation for the scheme
- No distinction between good and bad employees- The profit-sharing scheme is applicable for all the employees irrespective of the fact that they are good or bad workers. This is the reason why both efficient and inefficient workers often receive the same benefits, and this creates disharmony between the employees
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