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Compensation: Incentive Plans: Profit Sharing

An incentive based compensation program to award employees a percentage of the company's profits.

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
Disadvantages
  • Brings groups of employees to work together toward a common goal (the success/benefit of the company).
  • Helps employees focus on profitability.
  • The costs of implementing the plan rise and fall with the company's revenues.
  • Enhances commitment to organizational goals.
  • The pay for each employee moves up or down together (no individual differences for merit or performance).
  • Focuses only on the goal of profitability (which may be at the expense of quality).
  • 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.
  • Adherence to the FLSA requires employers to recalculate each worker's "regular rate" of pay. To overcome this limitation, employers may restrict this type of compensation to exempt employees.

When does Profit sharing work best?

When company earnings are relatively stable (or steadily increasing).

What is the best way to implement Profit sharing?

Meet with executives to develop a clear understanding of profit sharing. Develop various formulas and models to be used in predicting future gains and the costs associated with sharing those gains. Prepare rules.

Difference between Profit Sharing and Gain Sharing