New Profit Sharing Ratio

The partners of a business share profits and losses in a specified ratio and that ratio is known as the profit-sharing ratio. However, when a new partner is admitted into the firm, he gets his share of profits and losses from the old partners, or we can say that the old partners sacrifice a portion of their profits for the new one. The new ratio thus formed is called the new profit sharing ratio, and the ratio in which old partners sacrifice their profits is known as the sacrificing ratio. The sharing ratio is mutually agreed upon among the partners of the firm.

Examples of New Profit Sharing Ratio

1. A and B are partners and share profits in the ratio of 3:2. They admitted C as a new partner for 5/10 share, wherein she acquired 3/10 from A and 2/10 from B. The new profit sharing ratio among the partners would be-

Ans.

C’s share                       =      5/10

New Share                   =       Old Share – Share Surrendered

A’s new share               =      3/5 – 3/10 = 3/10

B’s new share              =      2/5 – 2/10 = 2/10

The new profit-sharing between A, B, and C will be = 3:2:5.

2. Ajay and Vijay are partners in a business firm sharing profits in the ratio of 4:1. They admitted Ram as a new partner for ¼ share in the profits, which he acquired wholly from Ajay. What would be the new profit sharing ratio of the partners?

Ans.

Ram’s share                  =      1/4

Ajay’s new share           =      old share – share surrendered

                                       =      4/5 – 1/4     =      11/20

Vijay’s new share          =      1/5

The new profit sharing ratio among Ajay, Vijay and Ram will be 11:4:5.

Difference between Sacrificing Ratio and New Profit Sharing Ratio

The Sacrificing ratio is the ratio in which the old partners sacrifice their share of profit for the new partner. Hence, the sacrificed portion is given to the new partner by all or just some of them. The need for calculating the sacrificing ratio arises at the time of admission of a new partner. As the name suggests, it lessens the profit-sharing of existing partners. Then the new profit sharing ratio is calculated among them, and it signifies in what ratio the profits and losses will be shared in the future.

Unlike sacrificing ratio, the new profit sharing ratio could be calculated when admitting a new partner or at the time of the partner’s retirement. When a partner retires from the firm, the profit-sharing of existing partners increases, and when one partner is admitted, the profit-sharing of existing partners decreases.

Need for Profit Sharing Ratio

When two or more persons set up a business, they must divide profits and losses in a specified ratio. However, if there is no agreement, they share the profits and losses equally among themselves. There is a number of factors that determine the ratio among partners. Some of them are-

• Based on responsibilities of the partners

According to the responsibilities taken up by the partners, their profit sharing is determined. If there are two partners in a partnership firm, named X and Y, and they agree to share profits according to the number of responsibilities each of them will bear. If X takes most of the operations carried on by the firm and Y takes some of them. They could agree to share the profits in the 8:2 ratio.

• Based on capital contribution

Generally, the profit-sharing ratio is calculated according to the amount of capital brought by each of the partners. For e.g., A and B are two partners, and A contributed Rs.100000 to the firm, while B contributed Rs.70000, then based on their contributions, their ratio will be 10:7. In a partnership, most of the time, partners bring capital as per their wishes. Often some partners contribute more than others. It is necessary to keep in mind the capital contribution of each partner while calculating the ratio.

The formula of New profit sharing ratio

Sacrificing Ratio = Old ratio – New ratio

Gaining Ratio = New Ratio – Old Ratio

Conclusion

Upon the admission of a new partner, it is essential to decide the new profit sharing ratio as the newly admitted partner is entitled to the profits. It is also calculated at the time of death or retirement of an existing partner, and the remaining partners get the gaining ratio. When a partner dies, the ratio of that person is removed from their ratio. Existing partners have to sacrifice a proportion of their shares in the event of the admission of a new partner.