How Does Profit Sharing Work

How does profit sharing work? While many companies offer this type of incentive, not all employees understand it. Profit sharing is a plan to reward employees for contributing to the success and profitability of a company, and a company can structure profit sharing in several different ways.

What Is Profit Sharing?
Profit sharing exists when a company earmarks part of the annual profits to be distributed directly to its employees. A company generally sets certain conditions for employees to be eligible to participate in the profit-sharing plan, such as number of years with the company, full-time employment or other criteria. The money for these compensation incentive plans comes from pre-tax profits, and the method of distribution varies.

Advantages Of Profit Sharing
Among the advantages of profit sharing is the motivation that it promotes among employees. When the company does well and earns a profit, the employees benefit directly. This, in turn, encourages employees to be more productive, look for ways to save money and cut costs and increase sales or services. Few perks are more motivating than money, and when employees feel as if they have a direct influence on the amount of money they can receive, morale, motivation and commitment rise. Profit sharing tends to succeed within a company that has steady or slightly rising profits and earnings. More volatile earnings blended with a compensation incentive plan may have the reverse effect on morale and motivation.

Disadvantages Of Profit Sharing
While profit sharing is a fine incentive plan for employees, there are some downsides. Because all employees participate equally in profit sharing, there is no distinction for individual contributions; in other words, the stellar employees get no greater reward than lesser contributors. Another disadvantage occurs if the company experiences dramatic fluctuations in earnings-employee profit sharing bonuses will be hard to predict from year to year, making budgeting more difficult. Finally, in the quest for high profits, employees may feel motivated to cut corners on the quality of goods or services.

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