Profit Sharing: Definitions, Concept, Objectives, Features, Steps, Merits

Everything you need to know about profit sharing. Profit sharing is a method of industrial remuneration under which an employer pays his employees a share in the annual net profits of the enterprise as fixed in advance.

The share is in addition to wages is not based on time or output. Profit sharing ill not a system of wage payment. It is given in addition to wages which usually covers all employees.

U.K “profit sharing” and co partnership Report, 1920 said, “profit sharing” is used “as applying to these cases which an employer agrees with his employees they shall receive in partial remuneration of their labour and in addition to their wages a share fixed beforehand in the profit realized by the undertaking to which the profit sharing scheme relates.”

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The percentage to be shared by the workers is often pre-determined at the beginning of the work period and is communicated to the workers so that they have some knowledge of their potential gains.

Learn about:-

1. Introduction to Profit Sharing 2. Definitions and Concept of Profit Sharing 3. Objectives 4. Features 5. Basis

6. Views of Management and Workers 7. Steps 8. Merits 9. Demerits 10. Schemes 11. Pre-Requisites of Effective and Successful.

Profit Sharing: Definitions, Concept, Objectives, Features, Basis, Steps, Merits, Demerits and Other Details

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Contents:

Introduction to Profit Sharing
Definitions and Concept of Profit Sharing
Objectives of Profit Sharing
Features of Profit Sharing
Basis of Profit Sharing
Views of Management and Workers on Profit Sharing
Steps of Profit Sharing
Merits of Profit Sharing
Demerits of Profit Sharing
Profit Sharing Schemes
Pre-Requisites of Effective and Successful Profit Sharing

Profit Sharing – Introduction

Among the group plans of ‘labour remuneration’ hardly any has gained so much of popularity as profit-sharing. In fact, it is fashionable for champions of democracy to stress the need for some form of profit-sharing in industry. This is a major departure from the accepted traditional concept of ‘profit’ according to which profit was considered to be the compensation due to the owner or the entrepreneur for the risks he undertook.

Thus, profit is no longer looked upon as the exclusive right of the capitalist. The workers are accepted as partners in an enterprise and, therefore, a share of the profit made by the concern with their active cooperation is considered to be their rightful due. Under a scheme of profit-sharing, the workers are paid a share of the annual profit over and above wages.

Since profit-sharing is based neither on time nor on output, it must be distinguished from the methods of wage payment. In fact, it can aptly be described as a form of added remuneration. The share of profits which is to be given to the workers is usually fixed in advance of the time when profit is calculated and distributed. As Seagar puts it, “Profit-sharing is an arrangement entered into, by which the employee receives a share, fixed in advance, of profits.”

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In spite of numerous incentive plans of wage payment, employer- employee differences have continued to exist, profit sharing and labour co-partnership have been tried with more or less success as part of an effort to lessen the present day industrial strife in India, profit sharing through bonus payment has been made compulsory.

Profit sharing is a method of industrial remuneration under which an employer pays his employees a share in the annual net profits of the enterprise as fixed in advance. The share is in addition to wages is not based on time or output. Profit sharing ill not a system of wage payment. It is given in addition to wages which usually covers all employees.

Individual incentive plans as they provide incentives to individual workers to work hard and earn more. There are two other plans viz. profit-sharing and labour co-partnership which are known as group incentive plans as they provide incentives to all the workers as a group.

Profit-sharing usually involves the determination of an organisation’s profits at the end of the fiscal year and the distribution of a percentage of the profits to workers qualified to share in the earnings. The percentage to be shared by the workers is often pre-determined at the beginning of the work period and is communicated to the workers so that they have some knowledge of their potential gains.

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To enable the workers to participate in profit-sharing, they are required to work a certain number of years and develop some seniority. The theory behind profit-sharing is that management should feel its workers will fulfil their responsibilities more diligently if they realise that their efforts may result in higher profits, which will be returned to the workers through profit-sharing.

Profit Sharing – Definition and Concept Propounded by ILO, Prof Seager, U.K “Profit Sharing” and Co-Partnership Report, 1920

According to ILO “profit sharing is a method of industrial remuneration under which an employer undertakes to pay his employees a share in the net profits of the enterprises in addition to their regular wages. Any bonus or gratuity paid by the employer on his own, is not a part of profit sharing.”

According to Prof Seager, ” profit sharing is an arrangement by which employees receives share fixed in advance of the profits.”

The International Co-operative Congress held in Paris in 1889 defined profit sharing as “an agreement (formal or informal) freely entered into by which an employee receives a share fixed in advance of the profits.”

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From the above definitions the characteristics of profit sharing scheme becomes clear.

(1) Profit sharing scheme is not a method of wage payment simply because it is not based on time or output, it is described as a form of an added remuneration.

(2) Under this scheme only profits are shared and not the losses of an organisation.

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(3) The amount to be distributed among workers is primarily depending on the profits of the organisation.

(4) The proportion of profit to be distributed among the workers should be determined in advance under an agreement mutually accepted and there is no scope for management to do any alteration or changes in it.

(5) This scheme is extended to all the workers in the industry irrespective of their nature of job.

(6) The arrangement of profit sharing is voluntary based on joint consultation between representatives of employer and employees.

(7) The payment is usually made in cash and not in kind

(8) The amount to be distributed among the workers is computed on the basis of some formula, which is to be applied in all circumstances.

Thus profit sharing is a distinctly progressive measure towards industrial harmony. In modern times profit sharing is rapidly growing concept and widely accepted by the entrepreneurs. Workers are now not treated merely as a factor of production but they are treated as partners of the organisation. The organisation has earned the profits just because of the sincere hard work done by the employees.

These two plans have been briefly discussed below-

The traditional concept of profit is that it is the reward of the entrepreneur for the risks he undertakes. But now profit is no longer regarded as the exclusive reward of the entrepreneur. The workers are now regarded as the partners in the enterprise and hence, they are considered to have a right to share in the profits of the enterprise along with the entrepreneur.

Under profit sharing scheme, the workers are paid a certain share of the annual profits in addition to their normal wages. Further, profit-sharing is not based either on time or output and hence, it should be distinguished from other methods of wage payment. Profit-sharing may be aptly described as a form of added remuneration.

Profit Sharing – 11 Common Objectives

Following are the common objectives of profit sharing:

(1) To achieve industrial harmony by developing healthy relations between the management and workers.

(2) To eliminate all types of waste in human and non- human resources.

(3) To motivate the workers for higher productivity and efficiency

(4) To install a sense of partnership among the employees and employer.

(5) To enhance employees interest in work and in company where they work.

(6) To attract competent and desirable employees in the company and retain them for a longer period.

(7) To reduce the rate of labour turnover and absenteeism.

(8) To ensure employee job security.

(9) To minimize administrative problems, simply means satisfied workers are better administered because profit sharing brings that kind of satisfaction. They feel part and parcel of the organisation.

(10) To provide social justice means, social justice demands more equitable distribution of wealth rather than its going into the hands of few. Profit sharing achieves some measure of social justice by observing the financial position of the organisation.

(11) Workers are getting additional remuneration in the form of profit sharing which ultimately improves the earnings of the workers and thereby financial position.

Profit Sharing – 7 Main Features

The main features of the profit sharing are:

(a) The agreement is voluntary and based on joint consultation made freely between the employers and the employees.

(b) The payment may be in the form of cash, stock of future credits of some amount over and above the normal remuneration that would otherwise be paid to employees in a given situation.

(c) The employees should have some minimum qualifications such as tenure or satisfy some other condition of service which may be determined by the management.

(d) The agreement on profit-sharing having been mutually accepted, is binding and there is no room on the part of the employer to exercise discretion in a matter which is vital to the employees.

(e) The amount to be distributed among the participants is computed on the basis of some agreed formula, which is to be applied in all circumstances.

(f) The amount to be distributed depends on the profits earned by an enterprise.

(g) The proportion of the profits to be distributed among the employees is determined in advance.

Profit Sharing – 5 Important Basis: On the Basis of Industry, On the Basis of Locality, Unit Basis, Department Basis and Individual Basis

(1) On the Basis of Industry:

Under this basis the profit of all units, which are belonging to a particular industry is pooled together to determine the share of profit for the labourers. If one of the units suffers losses in a particular year, still its workers are not deprived of their share in profit because other units have made a good profit.

(2) On the Basis of Locality:

When all the units of an industry situated in the same locality then profit of all of them pooled and then determines the share of profits to be distributed among the employees.

(3) Unit Basis:

The profit earned by the industrial unit is distributed among the worker and the employer. This system of profit sharing establishes a close relationship between the efforts of labour/ worker and rewards he receives.

(4) Department Basis:

This type of profit sharing scheme is applied when the various departments of an industrial unit have their own separate profit sharing schemes. The worker working in a particular department, share in the profit, made by that department. This basis also establishes a very closer relationship between the workers efforts and the reward he receives.

(5) Individual Basis:

Under this basis a worker would receive a proportion /part of profit which have been earned by the business organisation through the efforts of that particular work. This basis aims at bringing a direct and most intimate relationship between individual efforts of a worker and the reward. This basis of profit sharing is practically not feasible.

Profit Sharing – Views of Management and Workers on Profit Sharing

How the Management Views Profit Sharing?

Wages, like other prices, are determined in a market, in the present case, the labour market. Without doubt, a company earning profits should pay higher wages. But why should it pay more than the wage- rates prevailing in the labour market?

And if the management does agree to a profit sharing plan, it only shows its benevolence towards workers who, in turn, ought to feel grateful and not respond to calls for go-slow and strikes by irresponsible trade union leaders.

How Workers View Profit Sharing?

For workers, profit-sharing arrangement is their legitimate due in prosperity of the company which is largely the result of their own physical and mental efforts. They refuse to see it as benevolence of management. They look to bonus as a deferred wage, in other words, the wage already earned by them but its payment being withheld by company for a stated time.

Its object is to bridge the difference between what they ought to be paid and what is actually paid to them by way of normal wages. For this reason, they argue that bonus should be rightly regarded as part of the cost of production and hence a charge on the earnings of the firm.

In view of all this, as they put it, there is hardly any justification for the management to expect that they should keep away from trade unions.

However, whatever the views of the management or workers, the fact remains that the idea of profit- sharing is catching on. For industrial workers in India, for example, yearly payment of bonus is as much a part of their lives as yearly declaration of dividend for the shareholders. This has now become compulsory with the passing of Payment of Bonus Act, according to which payment of a minimum bonus has been made compulsory for industrial units employing 20 workers or more.

Profit Sharing – 5 Steps of Profit Sharing: Basis of Sharing, Net Profit, Labour’s Share, Individual Worker’s Share and Form of Distribution

We shall now take up a consideration each of these steps:

Step # 1. Basis of Sharing:

Profit-sharing may be introduced on any of the following bases:

(a) Individual basis – Each worker may be paid that share of the profit which the concern has earned due to his effort.

(b) Departmental basis – Each department may have its own arrangement of profit- sharing. The profits earned by a particular department will, then, be shared by all the workers working in that department.

(c) Unit basis – Here, profits may be shared by the workers working in each particular industrial unit. This can be recommended as the best basis because it provides for the sharing of profits earned by the efforts of the workers and the management of a unit.

(d) Locality basis – The profits of all the industrial units in a particular locality may be pooled and divided between workers and employers. This may, however, not be a suitable basis particularly in those localities where different types of industrial units are working.

(e) Industry basis – To place the whole labour force in a particular industry on the same footing, the profits of all units belonging to a particular industry may be added together and divided between the employers and workers. Thus, if a particular industrial unit suffers a loss, the workers there will not be deprived of a share of profit; in fact, they will be sharing the profit made by other units belonging to the same industry.

(f) Industry-cum-locality basis – Profit-sharing may be introduced also by adding together the profits of the various units of a particular industry operating in a particular area and giving a share as the combined profits to every worker of such units. For instance, the profits of all cotton textile mills in Ahmedabad may be pooled together for distribution among their workers.

Step # 2. Net Profit:

The profits are calculated on the ordinary commercial principles. For this purpose, provision is made for interest on capital, depreciation and reserves, etc. It will also have to be decided definitely whether other items of revenue expenditure like debenture interest, income-tax and dividend on preference shares, etc., are to be charged to profit to determine the divisible profit.

Step # 3. Labour’s Share:

The next step is to fix the proportion of profit which will be given to the workers, after all the necessary charges have been adjusted against it. A possible way will be to divide the profits between the owners and workers on the basis of the ratio between the total capital and the annual wage bill. According to the Encyclopaedia of Social Sciences, the employers will get at least three times the share of workers under this arrangement. In most of the schemes, the workers share only the profits; losses are shared only in rare instances.

Step # 4. Individual Worker’s Share:

Having ascertained the workers’ share of the profits it will be necessary to fix the basis of its distribution among individual workers. In some concerns, the length of service is the basis for such distribution. Some others adopt the number of hours worked during the year as the basis for determining each worker’s share of profit.

But generally, the wages earned by each worker during the year provide the basis for the distribution of profits among workers. The productivity and attendance of every worker may also be considered for this purpose.

Step # 5. Form of Distribution:

The part of the profit which is earmarked for distribution among the workers can be paid to them in any of the following forms:

(а) Cash – Each worker may be paid the amount of profit due to him in cash. This is the commonest form of profit distribution and is liked by the workers for obvious reasons.

(b) Transfer to pension or provident fund – The share of profit due to each worker or employee may be credited to his provident fund, or his pension fund. Under this form, however, the employer is merely accumulating the worker’s share to pay his pension. This is not justifiable because it should be his duty to pay the pension even otherwise.

(c) Cash and shares – The best form of profit-sharing is the payment of each worker’s share of profit partly in cash, and partly by the issue of bonus shares. When profits are thus distributed, workers become partners in the enterprise. They have a voice in the management of the concern and can, therefore, be expected to become more responsible and co-operative.

This type of profit sharing is usually termed as “co-partnership”. In England, the South Metropolitan Gas Company invested half of the workers’ bonus in the purchase of shares, and the employee shareholders were given the right to elect three out of ten members of the Board of Directors.

In 1926, the workers held shares worth £ 50,000 in the company. During World War II, the Delhi Cloth and General Mills Co., also issued bonus shares to its workers. Co-partnership appears to be an attractive solution to the complex problem of industrial relations, but it has not found favour with trade unions.

Profit Sharing – Top 7 Merits: Healthy Employer-Worker Relations, Improvement in Worker Productivity, Additional Earnings for Workers and a Few Others

The merits of profit sharing are:

(1) Healthy Employer-Worker Relations:

An important advantage of profit-sharing is that it promotes healthy employer-employee relations. There is merit in the employee’s argument that profits are largely due to employees’ hard work and efficiency and should not be wholly pocketed by the employer.

With reasonable profit-sharing agreement, they are less inclined to go on strike, or resort to “go-slow” or “work-to-rule” tactics. They realize that doing so would adversely affect the profitability of the organization with the result that their own share in profits would be reduced.

(2) Improvement in Worker Productivity:

Because workers have a vested interest in the profits earned by the organization, they perform their tasks efficiently. They realize that low production or increase in production costs would mean lower profits and therefore lower rates of bonus for them.

(3) Additional Earnings for Workers:

Profit sharing results in additional earnings for workers because the payment under it is over and above the normal wages payable to them. Thus, they are in a position to raise their living standards and experience a sense of economic security.

(4) Reduction in Labour Turnover:

Payment under a profit sharing plan is based on seniority and efficiency of individual workers. To be eligible for higher bonus, an employee needs to stay in the organization for a minimum period. A rolling stone gathers no moss and an employee who changes his employer at the drop of a hat cannot earn much bonus. Thus, profit-sharing arrangement reduces labour turnover.

(5) Less Need for Supervision:

As workers develop a vested interest in increased profitability of the organization, they do not need much supervision to push them to work hard. Even without supervision, they perform the assigned tasks to the best of their abilities and skills.

(6) Equity and Social Justice:

A profit sharing plan results in equitable distribution of profits between owners and workers. Just as increased profits increase distributable surplus among owners, they also result in increased earnings for workers. Thus, owners and workers are placed on an equal footing. Moreover, equitable distribution of profits will reduce the gap between the haves (owners) and have-nots (workers) and serve the cause of social justice.

(7) Selection of Better Personnel for Organization:

Operation of a profit sharing plan acts as an inducement for qualified personnel to join the organization as employees.

Profit Sharing – 9 Major Demerits: No Profit-Sharing in Case of Loss, Drag on Newly Setup Organizations, Uncertainty, Deliberate Suppression of Profits & a Few Others

Some of the demerits of profit sharing are:

Demerit # 1. No Profit-Sharing in Case of Loss:

Logically, the question of profit-sharing should not arise if the organization incurs a loss. However, under Payment of Bonus Act, an organization is required to distribute a minimum bonus even in case inadequate or nil profits. This move is justly opposed by employers and there is move to address this issue in the reforms agenda of the government.

Demerit # 2. A Drag on Newly Set up Organizations:

A newly set up organization will need reinvestment of its profits for stability and growth. If it is saddled with the responsibility of profit-sharing, it will find it difficult to stay and grow amid cut-throat completion.

Demerit # 3. Element of Uncertainty:

Even where workers are skilled and efficient, there is no guarantee that their organization would report profits at the end of the year. Sometimes, this may be due to factors beyond control, for example, depression, unfavourable market conditions, reduced demand for goods and services produced by the organization, and so on.

Recently, the global economic meltdown forced many companies, including foreign companies, to down their shutters. In such a scenario, workers will go without profit-sharing without any fault of theirs.

Demerit # 4. Deliberate Suppression of Profits:

An unscrupulous management may resort to evil practices, such as, manipulation of accounts to reduce profits. The result will be denial of profit-sharing to workers.

Demerit # 5. Inadequate Motivational Effect:

Profit-sharing takes place once in a year. It cannot retain its motivational effect for an entire length of the year. Sometimes employees’ share of profit is credited to their Provident Fund or Pension Fund accounts which further goes to make profit-sharing a less attractive motivational device.

Demerit # 6. Efficient and Inefficient Workers Treated Alike:

A profile sharing arrangement does not make any distinction between efficient and inefficient workers. They are treated alike, leading to discouragement of efficient workers.

Demerit # 7. Indifference of Trade Unions:

A profit-sharing plan does not find favour with trade unions because they see it as a strategy to keep workers in good humour and discourage them from joining trade unions.

Demerit # 8. Opposition by Employers:

As in case of trade unions, so with the employers who regard profit-sharing as a means to deprive them of their well-deserved reward for undertaking risks involved in running the business. Workers queue up to claim their share of profits but are nowhere in the picture when the employer suffers loss in business and also denied interest on capital invested in business.

Demerit # 9. Incentives Schemes:

There is little doubt that all incentive schemes—whether personal or group—are aimed to promote efficiency and productivity among workers. They do so by giving the workers a bonus on quantity and quality of output produced by them and keeping wastage of time and material under check. Further, if properly designed and implemented, such schemes may greatly promote healthy employer-worker relations and the spirit of cooperation all around.

But all incentive schemes suffer from one serious disadvantage – Because efficient and hardworking workers earn more than the less efficient and slow co-workers, there is a running warfare among workers. A typical argument advanced by the inefficient workers is that rather than introducing incentive bonus schemes, the organization should force managers to provide proper training and direction to workers to bring them on par with their efficient co-workers.

However, the fact of the matter is that incentive bonus schemes have pervaded all spheres of business and industry and have been so long in operation that both workers and employers have reconciled to their strengths and weaknesses alike.

Profit Sharing – Profit Sharing Schemes

The main value of successful profit sharing, says I.L.O. “seems to lie in the contributions they may make towards a spirit of collaboration and a sense of partnership between employers and workers.”

In the UK and the USA, profit-sharing plans have been in existence for many years though on a limited scale. Individual units have their own plans which are formulated on the basis of the agreements between labour and management. The sharing of gains takes different forms in different companies.

Some organisations make cash payments at the end of a specified period while others make deferred payments by investing workers’ share in P.F. and annuity, etc. Payment of profit in the form of shares is also not uncommon. The number of workers covered by profit-sharing schemes is, however, not very large in these countries. The scheme is not compulsory. The trade unions view the profit plans more as a fringe benefit than sharing the gains. They would not like to weaken their bargaining strength by accepting profits as a substitute for wage increases.

The statutory profit-sharing schemes have been introduced in some Latin American and Asian countries. The trade unions in the developing countries are not as strong as in the advanced industrial nations of Europe and America. They seek interference of the state in securing a part of the profit for them statutorily. It adds to their income and also provides them with a lump sum amount to meet certain expenses. In India, workers insist on the distribution of bonus at annual festivals such as Durga Puja or Diwali. While deferred distribution plans are popular in the affluent countries, in India the payment of bonus is mostly preferred in cash by the workers.

The practice of paying bonus started in India during the First World War. The ‘war bonus’ benefited the textile workers in the Bombay and Ahmedabad regions. The rate of bonus was 35% in 1918. When the war was over and profitability declined in the textile industry, workers continued getting bonus though at a reduced rate.

During the Second World War, the demand for bonus was made by workers in all major industries as the companies were earning huge profits. The Bombay Mill Owners’ Association decided to declare 12¹/₂% bonus. Judicial decisions went mostly in favour of workers’ rights to get bonus when companies earned profit. A committee on profit-sharing was appointed by the Government of India in 1948.

The committee felt that profit-sharing could be viewed from three different angles:

(i) As an incentive to production

(ii) As a method of securing industrial peace

(iii) As a step towards the participation of labour in management

The committee considered the first two points and concluded that the indirect effects on production would be sufficiently tangible to make an experiment in profit-sharing worthwhile. On the third point, the committee did not make any observation since it was outside its purview. The committee recommended the introduction of profit-sharing scheme in selected industries on an experimental basis.

The committee’s recommendations, however, did not find favour with the government. In 1961, the Government of India appointed a Bonus Commission. The Commission recommended that 60% of the available surplus should be allocated for distribution as bonus. A minimum bonus equivalent to 4% of the total basic wages and dearness allowance during the year or Rs.40, whichever is higher, should be paid to each worker.

The maximum bonus should be equivalent to 20% of the total basic wages and dearness allowance paid during the year. Employees drawing a total basic pay and dearness allowance up to Rs.1600 per month should be entitled to bonus with the provision that the quantum of bonus payable to employees drawing a total basic pay and dearness allowance of over Rs.750 per month shall be limited to what it would be if their pay and dearness allowance together amounted to only Rs.750 per month.

The available surplus for the purpose of bonus was to be determined by deducting from gross profits, depreciation; income tax and super tax; and returns on paid-up capital and reserves. The computation and payment of bonus should be unit wise. The major recommendations of the Bonus Commission were accepted by the Government of India. The Payment of Bonus Ordinance was issued on 19 May, 1965. In September 1965, the Payment of Bonus Act was passed by the Indian Parliament replacing the ordinance.

The statutory payment of bonus, however, has not served the purpose for which profit-sharing schemes were introduced. Far from improving industrial relations, bonus has been the most frequent source of unrest in India. The number of days lost due to bonus disputes has increased during the last few years.

Workers have been asking for higher wage rate than the prescribed minimum in the Act. There have been disputes on computation of the available surplus. Certain categories of employees who were excluded from the purview of the Act, such as those employed in non-competitive public sector undertakings have agitated for extending the scope of the Act to make them entitled to bonus.

In developing economies, there is a wide gap between the current wage and the fair wage. Workers look upon the statutory bonus as a part of their wages rather than an incentive for increasing productivity. If provisions for compulsory payment of bonus have not paved the way for improving labour-management relations, one does not have to go far to seek the answer. The continued rise in prices, poor living and working conditions, lack of social security, mismanagement of certain industries and the inter-union rivalry are the primary reasons of discontentment among the working class in the country.

Profit Sharing – Pre-Requisites of Effective and Successful Profit Sharing Scheme in an Organization

The following are the pre-requisites of effective and successful profit sharing scheme in an organization-

(1) Profitability of an Industry:

For implementation of profit sharing scheme the industrial units must run in profits. If an industrial unit is profitable then only this scheme can be adopted. In the absence of profits this scheme would not be succeed by the industry. Regular and assured profits must be earned by the industry.

(2) Computation of Surplus Profit:

From the profits of the company deductions like depreciation, development rebate, previous loses if any, if additional bonus is to be paid etc. all these expenses should be deducted from it. After providing for all these expenses should be deducted from it. And there must be an adequate surplus of sizable amount available for distribution among the workers.

(3) Fair Return on Capital:

A company should get fair return on their capital investment then only it is possible to implement the scheme of profit sharing.