What are Profit Sharing Plans?

Learn about profit sharing plans with Anil Kapoor
YouTube video

Case breakdown: Movie Om Jai Jagadish

The scene that you just saw shows Om (played by Anil Kapoor). He instructs Mr. Gupta, the accountant of the company to notify all singers, that they will receive 25% of the profits of the company.

In this blog, Learning Perspectives explores the meaning of profit-sharing plans.

What are Profit Sharing Plans?

Profit-sharing plans are attractive options that are given by the company besides salary. Profit-sharing is the payment to the employees in cash or stock. This payment is generally above the regular salary that the employee derives from the company. This profit sharing helps employees to earn a stake in the company.

Profit-sharing is different from the incentives or perquisites that are offered to employees. As these flow directly from the profits of the company. Bonuses, that are part of the variable pay program can be paid to employees, even when there are no profits in the company.

Types of Profit Sharing Plans:

Pension Plans:

Pension plans give employees a share in the company’s profits.  According to the annual and quarterly earnings of the company, employees would receive a share of the company’s profits. This serves as a retirement plan for the employee but there might be restrictions on withdrawals. Employee provident fund or National Pension scheme is different from this plan.

Profit-sharing brings stability to the workings of the organization. Employees are satisfied to receive such amounts over and beyond their regular income. Profit-sharing gives equal benefit to all employees, similar to the scene that we saw. This does not demarcate a good and a bad singer which can lead to demotivation for employees. This method won’t apply when the company is going through a phase of depression or is at the loss. The company won’t be able to provide such plans. Leading to a high degree of uncertainty in these plans.

How to calculate profit-sharing plans?

Profit-sharing is generally done based on the following factors:

a) Profitability of the business

b) Employee’s compensation and bonus awarded.

c) Limits set by the business.

There are different methods to calculate the profit-sharing plans in a business. One is the comp to comp method. This is a contribution on the basis of salary that the employee currently earns. Let us assume a company has two employees where employee A earns Rs.2,00,000 annually and employee B earns Rs.3,00,000 annually. Now if the company earns a profit of Rs.10,00,000 annually and wants to share 25% of the profits. Then, following calculation will be used:

Employee A = (2,00,000/5,00,000)*(.25*10,00,000)= Rs.1,00,000

Employee B = (3,00,000/5,00,000)*(.25*10,00,000) = Rs.1,50,000

This method is most commonly used. Rs5,00,000 is the total salary that the company gives out to the employees.

Another method is the pro rata calculation. This is allocation of the same percentage or fixed money to everyone. Age weighted method deals with awarding older employees higher percentage compared to younger employees.

These calculations are subject to the discretion of the company.

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