profit-sharing

Definition An arrangement in which an employer shares some of its profits with its employees. The compensation can be stocks, bonds, or cash, and can be immediate or deferred until retirement. Profitsharing allows for changing contributions each year. Contributions are determined by a formula to allocate the overall contribution and distribution of accumulated funds after the retirement age. Unless the plans are defined as an elective deferral plan, the contributions are not tax deductible. Contributions and earnings can grow taxdeferred until withdrawal.

Sometimes these plans are structured in such a way that employees share in their companies profits and potentially gain a greater interest in their firms success .‡ A profit-sharing plan is a type of defined contribution plan that is sometimes used as a supplement to a primary defined benefit plan.

disability. checks. Cash Plan At the time profits are determined. Deferred Plan Profit-sharing contributions are not paid out currently but rather are Deferred to individual accounts set up for each employee. death. . and sometimes at separation from service and other events. or stock. contributions are paid directly to employees in the form of cash. Benefits and any investment earnings accrued are distributed at retirement.Types of Plans ‡ There are three basic types of profit-sharing plans. The amount is taxed as ordinary income when distributed.

Profit-sharing (Corporatewide) Incentive Plans: Advantages ‡ Financial flexibility for the firm ‡ Increased employee commitment ‡ Tax advantages .

Profit-sharing (Corporatewide) Incentive Plans: Disadvantages ‡ Risk tied to firm performance ‡ Limited effect on productivity ‡ Long-run financial shortages .

Profit-sharing (Corporatewide) Plans Best When ‡ firm is large ‡ firms have multiple interdependent plants or business units ‡ firms face highly cyclical ups and downs in product demand ‡ used with other incentives ‡ firm wants to foster partnership .

Encourage employees to identify themselves more closely with the company by developing a common concern for the progress.Objectives of profit sharing 1. 3. To encourage better co operation between management and the employees. To stimulate a greater interest among employees in the affairs of the company as a whole. 2. .

To recognize that the employees of the company have a moral right to share in the profits they. have helped to produce. . 5.4. To reward success in business where profitability is cyclical. 6. To demonstrate in practical terms the goodwill of the company towards its employees.

. STOCK A portion of profit is paid in shares. CASH A portion of profit is paid in cash direct to employees. 2. 3.Types of profit sharing schemes 1. APPROVED PROFIT SHARING SHARES SCHEME(PSSS) The company allocates a portion to a trust fund which acquires shares in the company on the behalf of the employees.

. ‡ MIXED SCHEME (Combination of PSSS with cash) .Cont .

Eligibility All employees except director are eligible. ‡ Usually paid in relation to the pay earned or the time served between the date on which 1 year service was completed and the date on which the profit shares are paid.Main characteristics 1. ‡ Requires 1 year service to be completed. .

2. ‡ Combination of the above two methods. Formulae for calculating profit sharing. ( 3 approaches) ‡ Predetermined formula for distributing a fixed percentage of profit published formula ‡ Board to determine profit shares entirely at its non discretion.Cont . .

‡ Distribute profits as a fixed sum irrespective of earnings or services.Cont .. 3. ‡ Distribute profit in proportion to pay and some measures of individual performance. ‡ Distribute profit as a percentage of earning with payments related to length of service. Methods of distributing profit shares. ‡ Distribute profit as a percentage of basic pay with no increment for service. .

Cont . 4. Timing of distribution ‡ Annualy ‡ Twice a year ‡ Either at summer holidays or christmas . Amount distributed ‡ At directors discretion ‡ 2-20% or 5-10% 5.

 Profit sharing and industrial relation.Benefits of profit sharing  profit sharing and profitability. .

This would include companies which are starting-up and need to invest large sums in the business (e. or in research e.g. may be unsuitable when companies are not yet making a profit. many companies are not able to make contributions to their profit-sharing schemes. companies in the software industry). ‡ Profit-sharing schemes. In times of recession. . for some time.g. These companies would not expect to be making sustainable profits. companies in the telecommunications industry.THE LIMITATIONS OF PROFIT-SHARING SCHEMES ‡ Profit-sharing schemes are not always suitable in less favourable economic circumstances.

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