New Profit Sharing Ratio

Introduction: What is the Profit-Sharing Ratio?

The term profit-sharing ratio is an essential factor in partnership firms. Profit-sharing is the ratio in which the firm's partners divide the profit from the business operation. The profit-sharing ratio is usually mentioned in the partnership deed of a business. As is evident, it is an important factor for every partnership firm.

It is also notable that there must be a profit-sharing ratio which is followed by partners when a partnership firm earns profits. A partnership firm cannot exist without a profit- sharing ratio because in that case, the business’s profit cannot be divided among the partners after a profit is earned by the company.

Moreover, there may be disputes among partners regarding the share of the profit if the profit-sharing ratio is not fixed before any profit is earned by the partnership firm. So, having a pre-set profit-sharing ratio is an utmost need for any partnership firm.

What is meant by the New Profit-Sharing Ratio?

When a new partner joins a partnership firm, the profit-sharing ratio needs to be revised. A new ratio needs to be formed in which the proportion of the old and the new partner can be adjusted in the profit earned by the firm. This is called the new profit-sharing ratio.

In simpler words, the new profit-sharing ratio is the ratio in which existing and new partners will share the profits in the future after the inclusion of a new partner in the firm. If the new profit-sharing ratio is not fixed when a new partner joins the firm, then the profits of the firm will be equally distributed among all partners of the firm.

Therefore, as is evident, the new profit-sharing ratio is also an important part of a partnership business as it shows the proportions in which the future profit of the firm will be distributed among the partners, both old and new.

Need For A New Ratio In A Partnership Firm

A new profit-sharing ratio may be required in various instances during the operation of a partnership firm.

• A new profit-sharing ratio may be required if the existing members of the firm want to revise their proportion of the profits-sharing ratio. This may occur for various reasons, such as when the share of responsibility of the existing members changes in the partnership firm.

• The profit-sharing ratio may also need to be changed when a new member joins the firm, which is the most common reason for changing the profit-sharing ratio from the old to the new one.

• The profit-sharing ratio may also be changed in the case of the death or retirement of a new member of the partnership.

  However, it must be noted that in the case of the retirement of a partner, the calculation of the new profit-sharing ratio is done by removing the share of the person who is retiring. In such a case, the gaining ratio of the continuing members equals the retiring person’s share multiplied by the acquisition ratio.

Various Cases of Calculating A New Profit-Sharing Ratio

Calculation of a new profit-sharing ratio may be required in various instances. Some of these are the following −

Instance 1

In some cases, the sacrifice made by existing partners in order to provide the share of the new partner is not mentioned. In such a case, it is generally assumed that the existing partners are ready to sacrifice their old ratio. The sacrificing ratio of an existing partner can be calculated by subtracting the new profit-sharing ratio from the older one. In this case, the new ratio may be different but the proportion of profit share may remain the same.

Instance 2

In certain cases, the new partner may buy a share of the business from the old partners. In such cases, the old partners need not sacrifice any share at their end. So, the amount which the new partner has bought from the old associates must be deducted and then the new ratio should be calculated for all partners.

Instance 3

In the case of the death or retirement of a partner, the existing partner’s ratio will be the added sum of the old ratio plus the gaining ratio from the deceased or retired partner. In these cases, the existing partners gain a share from the deceased or retired partner’s absence.

Instance 4

In some cases, the old partners may sacrifice a portion of their ratio for the new partner who joins the partnership. In this case, the sacrificed portion should be deducted from the older members’ share in the profit-sharing ratio and then the new ratio should be calculated for all partners.

Instance 5

In some cases, a new entrant to the partnership may draw his entire share of the business from any one member. In this case, the share of the sacrificing partner must be calculated and deducted from the current share of the sacrificing partner. This share should then be added to the new partner’s ratio. The other partners do not have to sacrifice any share in such a case.

Factors Affecting Profit-Sharing Ratio

During the formation of a partnership firm, the profit-sharing ratio among the partners is usually mentioned in the partnership deed agreement. However, when no such agreement is formed, the profits should be distributed among the partners equally.

There may be various factors that are mentioned in the agreement depending on which the share of profits may be different for the partners of the firm. The most common two factors that affect the partnership’s profit-sharing are the following:

Contribution of Capital

The contribution of capital is the most common factor depending on which the profit- sharing ratio is formed. For example, If A and B contribute capital of Rs 50 lakh and 70 lakhs respectively, their profit-sharing ratio will be 5:7.

Responsibility shared by partners

There is another factor in which a partner looks after the business while the other just visit the operations. So, the profit-sharing ratio between them may be 6:4.

Mixed Factor

The profit sharing of a partnership firm may be related to the responsibilities and capital contribution shared by partners. For example, partner A may be involved in the operation of the business contributing a capital of Rs 20 lakhs while B has invested Rs 50 Lakhs but does not get engaged in the operations. Therefore, the profit-sharing ratio between them may be 4:5.

Conclusion

Profit-sharing ratios must be considered carefully by partners of partnership firms because earning profits is one of the most captivating reasons for starting a business. Having the knowledge can therefore help potential partners of partnership firms.

FAQs

Qns1. What is meant by the profit-sharing ratio?

Ans. It is the ratio in which the firm's partners divide the profit from the business operation.

Qns2.What is meant by the new profit-sharing ratio?

Ans. When a new partner joins a partnership firm, the profit-sharing ratio needs to be revised. A new ratio needs to be formed in which the proportion of the old and the new partner can be adjusted in the profit earned by the firm. This is called the new profit- sharing ratio.

Qns3. What are the two factors depending upon which a profit-sharing ratio is formed?

Ans. The two factors that are considered while forming a profit-sharing ratio are the capital contribution and sharing of responsibilities.