Profit refers to the financial benefit reaped by businesses after all remaining expenses are paid. To sustain daily operations, a company uses its revenue to pay for all operational costs including labour, raw materials, production, interest on the debt, and taxes. After all the expenses are paid, the residual income is called profit.
Profit serves as the reward of entrepreneurs and business owners for all the efforts and money they put to see the business come to fruition. For small companies, payback goes directly to the sole proprietor. Any gain or loss attained by the business is borne by the sole owner. But for large enterprises, distribution or sharing must be practised.
Understanding Profit Distribution
Profit distribution pertains to the allocation of an enterprise’s financial gain among shareholders, owners, and partners of the specific business. Private and commercial companies may also decide to allocate the payback for other purposes such as:
- Supplementary and reserve capital
- Coverage of losses
- Payment of rewards (employees)
- Granting of donations and payment for social funds
- Dividend payments
The distribution happens after calculating an enterprise’s overall costs up until the final payback is computed. The process of distribution is different for every business entity. It all depends on whether your firm is registered under a sole proprietorship, partnership, or corporation.
Since sole proprietors are also the sole owners of a business, they reap all the benefits a firm may obtain, including payback and income, as well as taxes, losses, and debts.
- Distribution for corporation
A corporation is a business entity owned by shareholders, managed by a board of directors, and
operated by a set of officers. It is a legal entity subjected to corporate tax under UK law. A corporation distributes its gain in three ways:
- Corporate profits taxes – all paybacks earned by the firm are subjected to taxes levied by the government. It is based on a computation where the financial gain, economic condition, and tax laws all play a role. About 40 to 50 per cent of a corporation’s gains go to taxes.
- Retained earnings – these are incomes earned by shareholders that are not received, paid, or distributed.
- Dividends – are financial gain distributed among a corporation’s shareholders, depending on the portion of their share. If a shareholder owns 20% of the company, then he/she should also receive 20% of the company’s payback.
- Distribution for limited liability company
In a limited liability company, the default rules of profit allocation depend on each member’s percentage of ownership. However, unlike corporations, LLC members may provide an alternative dividend allocation agreement to be filed in the LLC’s operating agreement. Once documented, all members are obligated to follow the new set of arrangements for distribution.
Before dividing the profits, an LLC needs to pay corporation tax at a specific rate, based on the country of operation. In the UK, the standard rate is 19%
- Distribution for general partnership
A general partnership is a business set-up where all partners are responsible for managing the company’s gains and losses. They are also personally liable to all debts and other liabilities incurred by the business.
A general partnership has the same earnings distribution as with a limited liability company. They are free to split profits any way they want—based on shares or work performance. However, general partners are still entitled to receive 5% interest on their share contribution, regardless of the financial result that year.
- Distribution for a joint-stock company
A joint-stock company is a business entity jointly owned by investors, where each owning is equal to the stocks they own. Unlike partnerships, joint-stock companies distribute their payback in the form of a net financial result, represented by the proportion of shares they hold. They also allocate 8% of their company’s profit to the reserve capital until it reaches one-third of the share capital.
Different business entities differ in almost everything, including the way they distribute their earnings. Profit allocation is tedious and complicated work, especially for large firms. It is better to hire or outsource the money work to professional accountants or accounting firms. This ensures that each partner or shareholder gets the actual amount of income they are owed, legally.