Profit sharing: Butteriss on human resources

 

Profit sharing occurs when companies decide to share a certain portion of their profits, say 10%, with all employees. Profit-sharing plans provide bonuses to employees based on a percentage of the company profit. Obviously, for the employees to receive a bonus, the company has to make a profit! The prime advantage of profit sharing is that it makes employees feel that their work is appreciated; it also makes them focus on revenues and expenses.

As a rule, profit-sharing bonuses are paid out once a year and can be given in the form of cash or on a deferred basis.

Cash schemes

Cash schemes are popular for a number of reasons:

• The reward is tangible and immediate.
• Employees have freedom of choice over how they use the cash.
• These schemes are easy to install and communicate.

However, from a tax perspective, if cash is given it is taxed in the hands of the employee as income received in the year it is received. Whether giving a bonus, salary, or cash, there is no difference in terms of taxation. They are all taxed in the same way and at the same rate. So it becomes a question of determining which is the most motivational form of bonus for the employer to give the employee.

Deferred schemes

Under a deferred payout plan, an employee’s share of company profits is placed in a trust fund and distributed at a later date. Distribution usually takes place on the employee’s employment retirement, termination, or death.

The most widely used deferred plan is the group Registered Retirement Savings Plan. In these, both the employee contributions and annual earnings of the fund are exempt from the employee’s taxable income until the employee actually receives the benefits. Group RSPs are the same as individual RRSPs, except that individuals pay into the company’s group scheme rather than their own individual plan. Usually, the contributions are shared between the employee and the employer. In other words, the employer may also pay into the Group RSP and in some cases, may make all the contributions. This is a great scheme for the individual because they receive a contribution to their RRSP without having to pay the full amount themselves.

The advantages of deferred plans are:

• They reinforce the employee’s efforts with the long-term success of the company.
• The value of the fund can be rapidly built up over time.
• Tax is deferred until the employee receives the income at a later date.

They reinforce the employee’s efforts with the long-term success of the company, because the individual will see that their payout of cash or shares is dependent on the success of the company in the future. Thus, they are more likely to make sure that their own and others’ efforts are directed toward its long-term success.

The value of the fund can be built up rapidly over time. This means that as the company becomes successful, the value of the shares can increase. Or, equally, investments of money in a good fund or account means that interest can accrue and the fund itself will increase in value.

Tax is deferred until the employee receives the income at a later date. This may be at a defined date when the shares are paid out, say in five years’ time, or when the employee leaves the company.

David Howe of Eckler Partners Ltd. suggests that it is best for a small company to set up a group RRSP to which only the employees contribute. As the company becomes more profitable and has more cash available, it might then consider matching employee contributions to the fund.

Insurance companies, banks, and mutual funds will set up group RRSPs for companies. (Some of these institutions may not issue a group policy unless the employers put some money into the plan.) Financial institutions will often help the company determine which employees will participate in the plan, whether the employer will make contributions, and the goal in introducing this type of plan.

The Royal Bank’sThe Definitive Guide to Managing Human Resources for Small Business Ownersoffers some good advice on profit sharing.“The keys to a good profit-sharing plan are clarity of purpose and realistic performance standards. For example, many small businesses still pay a flat Christmas bonus to all employees at the end of the year, but it’s not always clear in everyone’s mind how it is linked to the company’s profitability or whether individual performance had much impact.

“A profit-sharing format needs to be communicated to employees and linked to goals individuals have control over, such as their own productivity, sales volumes, or cost-saving initiatives.”

Karen Flavelle of Purdy’s Chocolates has a workforce that is divided among factory, administration, and retail store personnel. She pays factory workers and store employees on an hourly basis. Management in the factory, office, and store are salaried. Full-time salaried employees are involved in a profit-sharing plan.

David Haslam of Presidential Plumbing Ltd. is considering putting in place a profit-sharing scheme in the future. He says,“Right now, what I do in lieu of a bonus is throw a fabulous Christmas party every year to give recognition to the employees. There are a lot of companies that don’t do anything. In my industry, a bonus or profit-sharing atmosphere isn’t commonplace, although I don’t think it’s a bad idea. It’s an excellent way to motivate and stimulate your employees. Unfortunately, I haven’t been in a financial position to offer that.”

Copyright© 1999 by Margaret Butteriss. All rights reserved. Published by John Wiley& Sons Canada, Inc.
http://www.amazon.ca/Help-Wanted-Complete-Resources-Entrepreneurs/dp/0471643882

References

Butteriss, M. (1999).Help Wanted: The Complete Guide to Human Resources for Canadian Entrepreneurs.Toronto: John Wiley& Sons. pp.113-116

Tags: motivation, profit-sharing