Monday, December 14, 2015

Using Profit Sharing As Your Bonus Plan

While many companies pay commissions to salespeople and various incentives to others to drive  desired transactional results, privately owned companies can use Profit Sharing as their Bonus Plan for other designated employees.  It is actually not too complicated to accomplish.  The process begins by setting an annual Pre Tax Profit Margin target that must be met before Profit Sharing takes place.  That percentage would depend on what is common in a particular industry.  All companies would like to earn a 20% or higher Pre Tax profit; but that may not be possible in a specific industry.  Being more realistic, let's assume a 10% Pre Tax profit is the goal.  With Profit Sharing in place, any amount of money above the target becomes the Bonus Pool.   This will motivate bonus eligible employees to work smarter. 

Then the question arises as to how to divide the Bonus Pool among those eligible.  First of all, to earn a share of the Bonus Pool, the employee should have been on the payroll by no later than March 1 of the year in question so that he or she was in a position to make a contribution to the company's overall profit.   That configuration determines eligibility.  Then, a company must determine the number of shares of the Bonus Pool that will be provided to each eligible employee.  So, perhaps from the lowest level employee eligible to the highest senior manager in the Pool, the multiplier could go from 5 to perhaps 40 shares to best recognize the contribution to profitability and the responsibilities of each individual eligible for Profit Sharing.  Again, this has nothing to do with base salaries, which are based on experience, talent, education etc. 

By multiplying the total number of shares eligible for Profit Sharing and dividing that number into the amount of monies available for distribution, the share price is established.   So, if the share price is $500 and the employee is eligible for five shares, the Bonus would be $2,500.  At the same time the senior manager eligible for 40 shares would get $20,000.  However, there is one last aspect of the process and that should be used to determine the amount paid and that is the overall Performance Review Score.   First, to begin with, the employee must achieve at least 70% of his or her overall Performance Objectives to be eligible to earn a Bonus.  So, if the employee achieved 90% of his or her Performance Objectives and the full amount earned based on number of shares allowed was in this example $20,000, the employee would earn a Bonus of $18,000.    

Profit Sharing is a great way to motivate bonus eligible employees to work cost effectively because they know they are getting a piece of the company's actual profits.   This results in better expense management and looking for other ways to increase profitability.   Profit Sharing is a win win for all concerned and perhaps the best way to provide a Bonus Plan that ties monies paid to actual annual results. 

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