Profit sharing is a form of employee participation in company profits. It involves distributing a portion of the company’s profit—however defined—among employees. This financial incentive system strengthens employee engagement, boosts motivation, and aligns workforce interests with company performance.
Types of Profit Sharing:
1. Distribution-Based Profit Sharing
This method uses the amount of distributed dividends as the basis for employee participation and is primarily used in stock corporations. Two common forms are:
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Dividend Rate Method: Employees receive the same dividend rate as shareholders (often after deducting a base dividend), calculated as a percentage of their total compensation. While straightforward, this method can financially burden labor-intensive companies.
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Dividend Total Method: A portion of the total dividend is allocated to participating employees, regardless of individual compensation. A smaller workforce increases each employee’s individual share.
2. Company Profit Sharing
Based on net income from the tax balance sheet, this method deducts imputed costs, such as:
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Return on equity
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Entrepreneur’s salary
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Risk premiums
This approach ties profit-sharing more closely to economic performance and cost management.
3. Capital Gains Participation Scheme
This less common model seeks parity between employees and equity holders by using retained profit, adjusted for changes in capital value, as the basis for participation. However, since capital valuation is complex, this method is rarely applied in practice.
