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The amount you pay out in a cash profit-sharing plan should be enough to be meaningful and make a difference to employees but not enough to break your company's bank account. Before working out the details of your cash profit-sharing plan, give some thought to your objectives. Are you interested in giving a token payment to improve employee morale, or do you want to make a real difference in your staff's livelihood? Once you've defined your goals, you can design steps to achieve them.
TL;DR (Too Long; Didn't Read)
A cash profit-sharing plan distributes extra earnings right away rather than deferring them to be distributed in the future.
The Employee Profit-Sharing Agreement
Before distributing a share of profits to employees, your business should create a comprehensive plan for the logistics of this process. Parts of this plan can be decided in advance, such as whether you will base the distribution on hours worked, annual earnings or some other criteria such as participation in projects that are especially profitable.
In addition, you may arrange your employee profit-sharing agreement so the funds will be paid out at a time when your company's cash flow is most robust, or you may make disbursements in the form of stock rather than cash. A disbursement of stock would still qualify as a cash profit-sharing plan if the stock is allocated or distributed right away rather than vested and held by the company for a future time.
The percentage you pay out through your cash profit-sharing plan need not be consistent every time you disburse surplus. However, if your plan allows some flexibility in this area, your employee profit-sharing agreement should specify the guidelines for deciding how much to pay and the terms by which these guidelines can be modified.
What Is a Typical Profit-Sharing Percentage?
A typical profit-sharing percentage is 10 to 20 percent of the total profit amount distributed among employees. Researchers have found that an 8 percent distribution is usually enough to affect employee motivation and morale. The percentage you distribute may depend on the following variables:
- Overall cash flow. If your company is typically short of cash during certain times of the year, it may make more sense to retain a greater share of your earnings rather than distributing them through your cash profit-sharing plan. In this instance, it may be best for the overall financial health of your company to keep enough of your profits to get you through the lean times of the year.
- Frequency of profits. If your business earns a profit every year, it may be less important to distribute profits in any particular year than if you've undergone a rough patch and haven't paid out profits in a while. On the other hand, if your business has gone a few years without earning a profit, you may have more of an urgent need to retain a greater share of the successful year's surplus.
- Baseline employee compensation. Employees whose wages and salaries are typically low will probably be more appreciative of profit-sharing allocations than workers in higher pay brackets. If you keep wages low, and this tightly controlled payroll allows you to earn a greater profit, it makes sense to use a generous profit-sharing percentage.
Advantages of Cash Profit Sharing
A cash profit-sharing plan gives your employees a real-time, tangible reward for contributing to your company's success. They not only receive the wages or salary specified in your original employee agreement, but they also personally benefit from strong sales, efficient systems and tight teamwork.
Cash profit-sharing plans are wonderful motivators because they allow employees to make a connection between the success of the company as a whole and their own individual well-being.
- King University Online: How Does Profit Sharing Work?
- Inc.: How To Structure Bonuses And Profit Sharing Plans - It isn't That Hard
- KPM CPAs & Advisors: Profit-Sharing Plans for Your Small Business
- FitSmallBusiness: How to Set Up a Profit Sharing Plan
- Internal Revenue Service. "2021 Limitations Adjusted as Provided in Section 415(d), etc." Accessed Nov. 2, 2020.
- Emphasize to your employees or investors that your plan is just that: a plan that can be altered if the need arises.
- Show your profit-sharing plan to an accountant and/or an attorney to make sure you’re not making any mistakes.
Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.