I think it is important that everyone within the company understands the financial situation of the company, and that they have some form of a financial stake in it, other than just a regular pay cheque. The purpose being that everyone has both the knowledge, and the incentive, to individually and collectively make better financial decisions every day. And when I say everyone, I mean everyone, full-time, part-time, employees, contractors, whoever has committed to us and been with us for six months or longer. To make this happen we are going to try a profit sharing and financial transparency and education experiment for the next six months.
This isn’t a selfless act to be generous with co workers, rather it is a very selfish experiment to see if there is a return on this investment of sharing profits with all. The goal is to lower costs and increase revenues by aligning all minds within the company to achieve just that. This is the profit sharing experiment that I would like to try. The measure of success by which we will validate this experiment is that by the six month of having released profit sharing we have increased overall profits by twenty percent for months four, five and six over the same three months last year. Why not compare the full six months? I think it will take us the first three months to get everyone fully up to speed with the plan and the financial education, and it will only be in month four that we will truly be in a position to start realizing these gains. For greater certainty. This is a six month experiment and some part, or all of it, may change during or at the end of the six month period. We will do what we alway do, iterate, measure and learn.
With this in mind profit sharing is paid out monthly to enable a fast feedback cycle on the lessons learned and changes made. Further, we have to recognize that there can be wild swings in profit from one month to the next, and profit can be achieved on an accrual basis and as such the actual cash to back that profit may not be on hand when the profit is recognized. Therefore the profit that is eligible for sharing is profit on a cash basis, not accrual, and to smooth out the swings profit is paid out based upon a six month moving average. This eliminates the profit highs and lows and helps the company manage its cashflow to meet the profit sharing payout from one month to the next.
Further, the company can’t pay out all of it’s profit. The company needs to reinvest, build equity, and the owners need to be rewarded for the greater risk that they bear. Given this, we will allocate twenty five percent of the profit to the profit sharing pool. Once again, this is an experiment so that number may change once we have more experience with this plan.
I believe that everyone synergistically working as a team is what produces great results, however I recognize that there are some on the team with less experience and as such their influence on profit could be less, whereas those with more experience have more direct responsibility for making it happen, which is typically reflected in their base compensation - those with more experience and ability make more money. With this in mind I think everyone should partake equally in the profit sharing payout up to the amount of their base compensation in any given month. In other words the most that anyone can earn is twice their base pay, if that level of profit can be obtained. What this means is that the profit sharing paid out to higher earners, those with more responsibility and influence, will likely be a smaller percentage of their base compensation from one month to the next as everyone will receive the same amount up to their monthly base compensation. Some high earners may think this unfair as the impact of the more senior person’s contribution should in theory be greater. That’s why their base is higher. And that is completely accurate and as such the reason why I take the exact opposite position. The amount paid to higher earners in profit sharing, as a percentage of their base, will be less until everyone who makes less is fully paid out. They are paid more base compensation with the expectation that they will produce greater results. It is on them to produce those great results that allow them to fully max out their potential profit sharing from one month to the next. They should not be rewarded more than everyone else until such time as their leadership delivers those numbers.
For example there are eight people partaking in profit sharing in this sample company below. There is enough profit to pay the full base compensation of the two lowest base compensation earners, the next two and the two after that, but there is not enough to fully match the two highest earners and they will receive the amount paid out to the tier immediately below them.
Knowing how the company is doing based upon the profit allocation you receive is a good first step, but it is only part of the story. To really align everyone within the company and to make sure that they have all of the facts that they need to make decisions, day in and day out, they need to understand what makes up that profit. Therefore the financials of the company need to be transparent to all, and easily understood, and they are reviewed and discussed with everyone at the close of every month. Everyone needs to know and understand how we make our profit so that they can independently make better decisions. The end result is everyone knows how we are doing, where we have problems and opportunities, and they are rewarded for the decisions that they make based upon that knowledge.
And, as I have said above. This is a six month experiment to see if the act of paying out profit sharing and investing in financial transparency and education translates into greater overall profit.