When to Use a Cash Profit Sharing Plan in Your Business

Profit sharing is a strategy that companies use to share a portion of the company's profits with its employees. This can help bolster employee motivation, performance, and overall loyalty.

A cash profit sharing plan is a subtype of this strategy that uses monetary rewards to achieve these goals.

In this comprehensive guide, we'll explore the ins and outs of this strategy and help you kickstart your journey to ensure financial success.

What Is A Cash Profit Sharing Plan?

A cash profit sharing plan is a way to share a piece of your company's profits directly with your employees. Rather than managing complicated investment options, this plan aims to reward employees with cash (over and about the employee's annual compensation).

This is usually done regularly, like quarterly, or annually. But there's a slight catch - the money is taxed just like regular income.

Unlike other retirement-based plans, a cash-based plan is more straightforward. It's also a great choice for younger employees who aren't worried about their retirement savings just yet. Instead, they may want extra money now to start a family or purchase a house.

Although it doesn't have the tax advantages of some other plans, the simplicity of a cash plan and the quick payouts make it a fantastic motivator. It may also be a good way for companies to motivate employees when they don't necessarily have the budget for more expensive or intricate plans.

When Should I Use A Cash Sharing Plan For My Employees?

So, when should you consider using this type of profit sharing plan for your company? Well, there are numerous scenarios in which these plans can be more advantageous for businesses and their employees.

Firstly, it may be beneficial for companies that experience variable annual profits. This is because cash-based profit sharing plans are more flexible. In contrast to fixed contributions, the variable nature of this sharing plan allows you to adjust your payouts based on your quarterly or annual earnings.

In other words, it's dependent on your company's financial performance. For instance, in more prosperous years, your employees can benefit from a share in increased profits.

Secondly, it may be an appropriate plan for small to medium-sized businesses with stable financials. In these instances, profit sharing plans can be a cost-effective way to motivate and retain your top employees.

For smaller companies, it can be challenging to implement complex and costly initiatives, which makes a straightforward cash-based approach to rewarding employees more practical. It gives employees a more tangible and direct bonus system without placing unnecessary strain on your company's financial resources.

You may also want to consider this type of profit sharing plan to keep your employees happy. By linking their rewards to how well your company is doing (or your company's profits), they will be more motivated to work harder. Plus, receiving a palpable reward like cash can foster loyalty and appreciation among your workforce.

Considerations before implementing

Before you and your profit sharing partner set up a cash-based plan, there are some things you'll need to consider. Without understanding certain factors like the financial commitment or legal implications of a profit sharing plan, it's unlikely that it will produce the results you're after.

Keep the following points in mind before you draw up or implement your profit sharing plan:

Financial commitment

One of the most important factors to consider is the financial commitment that is involved in a profit sharing plan. To do this, you'll need to thoroughly assess your financial capabilities and commitments. While it may not require as strict of a commitment as contributing to a retirement plan, it still requires an ongoing commitment to reward your employees.

Simply put: If you can't afford to give out cash bonuses (even during more profitable years), then it won't work. And if you can afford it, you'll need to carefully calculate your company's budget to ensure that you don't cause any financial strain.

Luckily, there is no contribution minimum you need to pay your employees - but there may be a contribution limit, so make sure to familiarize yourself with that.

Impact on company culture and employee expectations

Introducing a cash-based profit sharing plan means evaluating whether it aligns with your company culture. Consider whether the plan compliments your business's values and goals, or whether it could be adjusted for better cohesion.

It's also important to manage your employee's expectations through clear and regular communication regarding the plan. Otherwise, you may be faced with potential employee dissatisfaction.

Legal compliance

Unlike some other plans, cash-based profit sharing plans lack tax shelters. And, although employees pay taxes on their bonuses, you'll need to make sure that you comply with non-discrimination rules. This means that you need to fairly share the percentage of your annual profits you've chosen to distribute among all of your eligible employees.

In some cases, you may need to conduct annual testing to ensure your business is compliant with these rules. However, if these bonuses are a fixed percentage of employees' pay, this testing may be unnecessary.

The easiest way to ensure you're legally compliant with any rules and regulations is to hire a legal professional. They can provide you with the necessary advice and legal counsel to stay adherent to the law.

Benefits Of Cash Profit Sharing Plans

There are several benefits of profit sharing plans. Still, there are some that stand out more than others that you may be interested in before deciding whether this plan will suit your business. These benefits include (but are definitely not limited to):

Employee motivation and loyalty

Cash-based profit sharing plans give employees a direct financial incentive to contribute to the company's success. By making bonuses synonymous with the company's profits, they'll be motivated to work harder.

In turn, this can boost their overall productivity. It can also foster stronger company loyalty since your employees now have a vested interest in how well the business does. The more profits there are for the business, the more cash there is to go around in bonuses.

Tax advantages for the business and the employees

While a cash-based profit sharing plan is not tax-sheltered, it does offer advantages for both businesses and employees. Companies can benefit from tax-deductible contributions, which can help to provide some financial relief.

Although employees will be taxed on their cash bonuses, they still benefit from this profit sharing plan. This is because they're receiving an increase on top of their regular salaries, which can help to contribute to their financial well-being.

Flexibility in business contributions

The flexibility of this type of profit sharing plan means that you can adjust your contributions based on how well your business is doing.

The more successful the company is, and the more profits the company is bringing in, the higher the contributions you can allocate to your employees. But, when you're experiencing a challenging financial year, you can simply lower your contributions. This can save you from making other tough financial choices like layoffs.

Step-By-Step Guide To Setting Up A Cash Profit Sharing Plan

Once you're ready to create a cash-based plan, you can start to create a profit sharing plan document. You can add percentages, eligibility criteria, and a formula for calculating how you share your profits. Then, you can explain the plan to your employees to prevent misunderstandings and motivate them to earn these bonuses.

Step 1: Determining the company's profit sharing percentage

Decide on is the profit sharing percentage you're going to adhere to. Generally, you can calculate how much of the company's annual earnings are distributed to employees by looking at each individual's pay compared to what other employees are paid.

For example, if all your employees earn 3% of the profits together, then the easiest way to determine a percentage is to distribute 3% of the profits. Of course, this number can fluctuate depending on your business's finances at any given time.

Step 2: Establishing eligibility criteria

Next, you're going to want to figure out who is eligible to receive these cash bonuses. By coming up with a list of criteria that they will need to meet, you can include or exclude groups of employees to customize your plan.

Typically, eligibility criteria may include things like:

• How long individuals have been with the company
• Whether an employee is a senior or junior worker
• Specific job titles

Step 3: Creating a profit sharing formula

You'll then need a formula to determine how to share the profit pool with your employees. Consider creating a formula based on a portion of their salaries, their performance, and more.

For instance, if you create a formula based on their quarterly or annual earnings, then you may decide to reward your employee with 5% of their salary. So, if your employee earns $130,000 per year, you would reward them with $6,500 cash. Of course, this will change based on the salary of each individual.

Step 4: Communicating the plan to employees

Explain the profit sharing plan with your employees as comprehensively as possible, ensuring that they have a good understanding of what the sharing plan means in terms of their rewards.

You can also explain the profit sharing formula to them to give them an idea of the financial bonus they can expect.

Just be sure to update them on any changes to the profit sharing plan to make sure your company is as transparent as possible by effectively managing your employee's expectations.

Other Types Of Profit Sharing Plans

Deferred profit sharing plan (DPSP)

A deferred profit sharing plan involves setting aside a portion of the company's profits to be distributed at set times. The most common type of deferred profit sharing plan is where the contributions are placed into retirement savings. Then, when the employee retires, they receive their payout.

Unlike cash-based profit sharing plans, DPSPs are more complex and require more planning and a stricter financial commitment. Cash-based profit sharing plans are easy to draw up and execute. They're also flexible enough to tinker with when necessary.

Stock-based profit sharing: Employee stock ownership plan (ESOP)

Employee stock ownership plans are exactly what they sound like - rather than a monetary reward, employees are given specific shares of stock. While this might encourage more productivity and company loyalty, shares may fluctuate.

When shares fluctuate, they may depreciate in value. This might affect how employees perceive their rewards, particularly when the market changes. This is similar to how cash-based profit sharing plans can be tweaked to suit the company's profits. However, with cash bonuses, the reward is more immediate and, therefore, the changes in bonuses may be more tolerable by your workforce.

Phantom stock and stock appreciation rights (SARs)

Both phantom stock and SAR sharing plans are widely used within businesses in certain industries.

With phantom stock, employees receive cash bonuses that follow the company's stock price - even though they don't actually own any stock. On the other hand, employees can earn money when the company's stock price goes up with stock appreciation rights.

The main difference between a cash profit sharing plan and phantom stock and SARs is that employees actually own shares in stock with the former, while the latter doesn't involve any real ownership.

Looking To Set Up A Profit Sharing Plan? Download Our Free Template:

Want to know how profit sharing could work for your business? Check out ShareWillow’s Profit Sharing template.

As a business owner, nothing is more important than encouraging employee engagement and ensuring your company's financial success. And what better way to do that than by implementing a cash-based profit sharing plan?

Crafted by our experts at ShareWillow, this resource simplifies the process of setting up a strong and effective profit sharing plan.