Profit sharing refers to an incentivized compensation program that gives employees a certain percentage of the profits made by the company. The amount that is given depends on the earnings made by the company in a certain period. As opposed to bonuses, profit sharing only applies when the company earns something. But how does profit sharing work? Today we will learn more about it, analyze some examples, and see its pros and cons.

Here you have a clip explaining the difference between bonuses and profit sharing:

How Does Profit Sharing Work?

There are several ways in which profit sharing can work. Most often, the company brings part of the pre-tax profits into a pool which is later distributed to the eligible employees. The amounts it gives can vary according to the salary. Moreover, profit sharing can work as a supplement for the benefit plans as well. In general, this process takes place after the business determines what’s their final profitability for that year.

Here are the steps for a profit-sharing plan that are set in place by the Department of Labor:

  1. Write a plan document;
  2. Arrange a trust for the assets included in the plan;
  3. Develop a system to keep your records;
  4. Offer the information in the plan to all the employees that are eligible.

It’s essential to keep a detailed record of the way in which the plan gets distributed to the employees. Of course, you can later update the plan, but ensure you make the right decisions.

This clip explains the entire process in detail:

Types of Profit Sharing Plans

There are two types of profit sharing plans:

1. Cash Profit Sharing Plan

With this type, the contributions are given directly to the employees. Thus, they receive cash, stock, or checks. Later, the amount gets taxed as any ordinary income.

2. Deferred Profit Sharing Plan

In this case, contributions are deferred to all the individual employee accounts. The benefits, as well as any other investment earnings that were accrued, are then distributed in case of retirement, death, disability, separation from service, etc. A cash plan is usually seen as an employee bonus, while the deferred plan is a supplement to other benefits.

Profit Sharing Examples – Case Study: Huawei

There aren’t too many companies to give as an example when it comes to profit sharing. It may be successful for small businesses, but how does profit sharing work when it comes to big organizations? Waitrose, which is a British online grocer, is one of the best examples. However, today we are going to focus on a tech giant, namely Huawei.

This is a Chinese telecom founded in 1987 by Ren Zhengfei. It’s a private company that is owned by its employees. Today, more than 170,000 people work there, helping around 3 billion people worldwide. What makes it remarkable is the fact that it’s the only Chinese company that gets more sales revenue from outside China than inside it.

What’s even more impressive about it is the fact that when designing the company, Zhengfei had no idea about the incentive systems that existed in the West. He simply designed an Employee Stock Ownership Plan (ESOP). Today, he holds just 1.4% of the total share capital of Huawei. The rest is owned by its 82,471 employees, as the 2014 Annual report issued by Huawei showed. Currently, the total of the employees’ bonuses, salaries, and dividends equals 2.8 times the annual net profit of the company. As such, you can see how adopting a profit-sharing plan can work better than other business options.

Profit Sharing Advantages and Disadvantages

Now that you know how does profit sharing work and you’ve seen examples of it, it’s time to see what are its pros and cons.

Profit Sharing Pros

  1. It brings employees together. They manage to work for a common goal and they all aim for the success of the company.
  2. The additional income helps the employees have a comfortable life. As we know, the more comfortable people are in their personal lives, the better they work.
  3. It motivates people. Employees are interested to work more and be more efficient if they get some extra financial gain whenever the company makes a profit.
  4. It promotes the employee’s well-being. People feel more cared for and thus more interested in taking care of themselves.
  5. Employees focus on profitability. This determines them to work together as a team to reach the goals for the company.
  6. It brings the employee and the employer closer. Since they have common goals, they feel closer to each other.
  7. It makes people more committed.
  8. Employees identify with the company. They will feel as if they belong to it, making them feel at home.

Profit Sharing Cons

  1. Individual employees get raise equally. This means that the employer won’t consider merit or promotion when it comes to raising salaries.
  2. Employees at the top are more motivated. They get a larger percentage of the profit share, so they are more determined at work.
  3. Personal earnings can be affected. When it comes to smaller companies, there can be drastic fluctuations in the earnings of the company. This can further affect the personal earnings of each of the employees.
  4. People get money anyway. The employees will get their share of the profit regardless of how much they contributed to the company. This might be unfair for some of them and, in time, can even lead to a decrease in motivation.
  5. People may focus on profit. Instead of thinking about the quality of their work, people may focus more on the profit they’re getting.
  6. It triggers a low motivation. Just as we said before, in time, the motivation will diminish. Thus, employees will consider the extra money their right and will stop working hard for it.

To sum it all up, the profit sharing strategy can return huge results if it’s used wisely. Despite having its own disadvantages, many employees love it because of the extra cash it brings in. What’s important is to think whether this incentive method will work well for your company and team. If so, don’t waste time and start applying it right away.

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