Profit Sharing Ratio

The profit-sharing ratio is a ratio through which the profits and losses of a partnership are calculated. The profit-sharing ratio is determined by the partners and subsequently recorded in the business agreement. This ratio projects the percentage of total profit, attributed to every partner. 


Meaning of New Profit Sharing Ratio

New profit sharing ratio is the proportion in which the old partners, as well as the new partners of a firm, agree to distribute the future profit of that organisation. 

It is necessary to decide the new profit-sharing ratio when a new partner joins a business because in future he/she will be entitled to share the profits. 

However, if this ratio is not agreed at the time of admission of a new partner, the profit will be distributed equally among all the partners, existing and new. 

When is New Ratio Introduced?

There are different scenarios when a business can have a new ratio.

  • If the partners want to revise their existing profit sharing ratio without inclusion or exit of any member

  • When a new partner joins a firm

  • At the time of death or retirement of an old partner

However, the calculation of the new profit sharing ratio in retirement is done simply by removing that retiring person’s share. In this scenario, the gaining ratio of the continuing members will be = retiring person’s share* Acquisition ratio. 

Find out what is Acquisition Ratio and Sacrificing Ratio to solve advanced problems on this topic. 

Instances of Computing New Profit - Sharing Ratio

This ratio is calculated differently for different scenarios. A few profit-sharing examples are given below.

  1. Case 1: The share of a new partner is given without mentioning the sacrifice made by existing or old partners. In this case, it can be assumed that the existing partners will sacrifice on their old ratio. To calculate a partner’s sacrificing ratio, you need to deduct his/her new profit-sharing ratio from its older counterpart. Even though the new ratio will be different figuratively, the profit-sharing proportion might remain the same for former members. 

  2. Case 2: When the new partner will buy a share from old associates in a particular ratio. In this instance, the existing partners do not make any sacrifice from their end. Therefore, firstly you only have to deduct the amount in which a new partner has purchased his/her share from existing members and then the revised ratio will be calculated for everyone. 

  3. Case 3: On retirement or death of a partner, a new profit-sharing ratio of remaining partners will be additions of old ratio and gaining ratio as the existing partners gain his/her share from the retired partner’s absence.  

  4. Case 4: An incoming partner obtains his/her share from existing partners who have made a sacrifice to favour the new one, in a particular ratio. In this case, the shares sacrificed by old partners will be deducted from their share, and that would be added to a new member’s share. Then a new profit-sharing ratio will be calculated. 

  5. Case 5: When a new partner draws his/her entire share from any one partner of the business. In this respect, first, you have to compute the sacrificing share of that particular partner and have to deduct it from his/her current ratio and that share will be credited to the new partner’s share. However, the ratio will be unchanged for other existing members as they have not sacrificed their share.

How to Calculate New Profit Sharing Ratio?

The formula of a new profit sharing ratio can be different considering several circumstances, but this following illustration is one of the ways to calculate it. 

Q. A, B and C are partners sharing profits in the ratio of 3:3:2. C retires, and his share is taken up by A. Calculate the new profit sharing ratio of A and B. 

Solution: Share gained by A = 2/8

Gaining ratio of A and B = 2/8:0 that is 1:0 [Since B has not gained anything from C, therefore, share obtained by B= 0]

New share of continuing partner= Old share + share gained

A = 3/8+ 2/8= 5/8

B = 3/8+0= 3/8

Hence, a new profit-sharing ratio of A and B is= 5/8: 3/8 that is 5:3. 

However, like a new ratio, there is no fixed profit-sharing formula that exists as the profit of an organisation is distributed according to each partner’s varying contribution. 

Partnership Profit Sharing Ratio Problems 

1. X and Y are two partners sharing profits in the ratio of 3:1. Z is admitted for 1/8th share of profits. Calculate the new profit-sharing ratio of X, Y, and Z. 

Ans. Since Z’s share is given without mentioning what Z obtains from X and Y, it is assumed that Z receives a share from X and Y in their old profit-sharing ratio. Hence, the sacrificing ratio by X and Y will be= 3:1. 

Firm’s share= 1

Remaining share= 1-1/8= 7/8

Now, 

X’s new share= 3/4* 7/8= 21/32

Y’s new share= 1/4* 7/8= 7/32

Z’s new share= 1/8* 7/8= 7/64

New profit-sharing ratio of X: Y: Z= 6:2:1. 

2. Manish, Kunal and Vineet are partners sharing profits in the ratio of 5:3:2. Manish retires, and the new ratio between Kunal and Vineet is 2:1. Find the gaining ratio. 

Ans. 

Share gained = New share - Old share

Kunal = 2/3 - 3/10= (20 - 9)/30 = 11/30.

Vineet = 1/3 - 2/10= (10 - 6)/30= 4/30.

Therefore, the gaining ratio of Kunal and Vineet is = 11/30:4/30 that is 11:4. 

Try to memorise different new profit sharing ratio formulas for various instances and practice as many problems as you can to score better in the final examination. 

For more such topics on partnership and solved maths, stay tuned to Vedantu’s website. 

FAQ (Frequently Asked Questions)

1. How to Calculate a new Profit Sharing Ratio?

Ans. When a new partner buys his/her share of profit from an old partner, the new profit sharing ratio of the former partner can be calculated by deducting the sacrifice made by the old partner from his/her existing share of profit.

2. What is the Sacrificing Ratio in a Partnership?

Ans. It is the ratio in which the old partners of a partnership sacrifice their shares in favour of a new partner. It is calculated when a new partner enters into partnership.

3. How do Corporations Distribute Profits to Their Owners?

Ans. The total corporate profit is distributed into 3 ways- a) one part is used to pay corporate profit taxes, b) undistributed profit hold by corporate to finance capital investment; c) the remaining portion is paid out as dividends to corporate owners or shareholders.

4. What is Gaining Ratio?

Ans. This ratio is calculated at the time of retirement or death of a partner. In this ratio, the existing partners gain the share of profit of the outgoing partner.