What Is Profit Sharing and How Does It Work?

What Is Profit Sharing and How Does It Work?

Incentive Plans: Profit Sharing: An incentive-based compensation program to award employees a percentage of the company’s profits. 

Profit sharing is a type of pre-tax contribution plan for employees that gives workers a certain amount of a company’s profits. The profit-sharing payments depend on the:

• Business’s profitability
• Employee’s regular wages and bonuses
• Amount set by the business

How does Profit sharing work?

The company contributes a portion of its pre-tax profits to a pool that will be distributed among eligible employees. The amount distributed to each employee may be weighted by the employee’s base salary so that employees with higher base salaries receive a slightly higher amount of the shared pool of profits. Generally, this is done on an annual basis. 

Advantages

1.Brings groups of employees to work together toward a common goal (the success/benefit of the company). 

2.Helps employees focus on profitability. 

3.Enhances commitment to organizational goals. 

4.The pay for each employee moves up or down together (no individual differences for merit or performance). 

Disadvantages

1.The costs of implementing the plan rise and fall with the company’s revenues.

2.Focuses only on the goal of profitability (which may be at the expense of quality). 

3.For smaller companies, these plans may result in drastic swings in earnings for employees which the employees may find difficult to manage their personal finances. 

See Also.

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