Difference Between Sacrificing Ratio and Gaining Ratio

Uncover the key differences between sacrificing ratio and gaining ratio in business partnerships. Learn how these ratios determine the share of profits and capital among existing and new partners with an organization.

Sacrificing and gaining ratios are key components in partnership accounting and are crucial in determining profit-sharing and redistributing ownership interests. By establishing clear rules for profit-sharing and ownership redistribution, these ratios create a sense of trust among partners and encourage them to work collaboratively towards the company’s profitability. In this blog we will cover the difference between sacrificing ratio and gaining ratio.

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Tabular Comparison – Sacrificing Ratio vs Gaining Ratio

Main Difference – The sacrificing ratio determines the ratio in which the existing partners give up their share of profits/losses in favor of the new partner, while the gaining ratio determines the ratio in which the existing partners receive the share of profits/losses when a partner leaves the business.

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What is Sacrificing Ratio?

The sacrificing ratio refers to the proportion in which the existing partners sacrifice their share of profits in favor of a new partner who enters the partnership.

Sacrificing Ratio Formula

The sacrificing ratio is the difference between the old ratio (the profit-sharing ratio before the new partner was admitted) and the new ratio (the profit-sharing ratio after the new partner was admitted).

Sacrificing Ratio = Old Profit Sharing Ratio – New Profit Sharing Ratio

For example, if there are two existing partners, A and B, sharing profits in the ratio of 5:2, and a new partner C is admitted with a profit-sharing ratio of 4:2:1 (A:B:C).

In the given scenario, the sacrificing ratio of A and B would be calculated as follows:

• For A: Old ratio – New ratio = 5/7 – 4/7 = 1/7
• For B: Old ratio – New ratio = 2/7 – 2/7 = 0

So, the sacrificing ratio of A and B is 1:0, which means that partner A is sacrificing 1/7th of his share of profits in favor of the new partner C, while partner B is not sacrificing any of his shares.

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Why is the Sacrificing Ratio Important?

When a new partner is admitted into the partnership, the new partner usually brings some capital and goodwill to the business. In return, the new partner is given a share in the business’s future profits. The existing partners usually give This share of profits, which means they have to sacrifice a part of their profits.

Related Read – Financial Ratios Cheat Sheet: A Complete Guide to All Ratios

What is Gaining Ratio?

The gaining ratio refers to the ratio in which the remaining partners of a company share the profits and losses after a partner retires, resigns, or leaves the partnership. This ratio determines the redistribution of the outgoing partner’s share among the remaining partners. 

Gaining Ratio Formula

The gaining ratio is calculated by comparing the partners’ new profit-sharing ratios after their exit to their previous profit-sharing ratios.

Gaining Ratio = New Profit Sharing Ratio – Old Profit Sharing Ratio

Let us understand this concept better with a use case for the gaining ratio:

Consider a partnership business with three partners: A, B, and C. They share profits and losses in the ratio of 5:3:2, respectively.

Now, Partner C has decided to retire from the business. As a result, the profit-sharing ratio between A and B needs to be re-evaluated. After negotiation, they decide to share future profits in the ratio of 3:2 (A:B).

The gaining ratio is the difference between the new ratio and the old ratio for each partner:

• For A: New ratio – Old ratio = 3/5 – 5/10 = 1/10
• For B: New ratio – Old ratio = 2/5 – 3/10 = 1/10

So, the A and B gaining ratio is 1:1, which means that both partners A and B are gaining an equal share of C’s previous share of profits due to C’s retirement.

Why is Gaining Ratio Important?

At the time of the departure of a partner, the gaining ratio helps determine how the outgoing partner’s share of profits/losses will be distributed among the remaining partners. 

The gaining ratio reflects the ownership interest or profit-sharing arrangement change among the remaining partners.

The gaining ratio has implications for the division of future profits, as it may lead to a change in the profit-sharing ratio among the remaining partners. It also affects losses and their distribution.

Real-World Context: Sacrificing and Gaining Ratios

Understanding the sacrificing and gaining ratios is crucial for fairness in profit-sharing and maintaining strong, transparent relationships between partners. These ratios can influence key decisions, such as how the partnership adapts to changes, attracts new investors, or manages the impact of a partner's departure on the remaining partners' workload and responsibilities."

Real-World Example:

Consider a small tech startup with three partners: Smriti, Jatin, and Lisa. The profits are divided in a 5:3:2 ratio. After a few successful years, Smriti decides to retire and sell her share to a new partner, Ahaan. The remaining two partners, Jatin and Lisa, must decide how to divide Smriti's share of profits.

They calculate the gaining ratio and find that Jatin will gain a larger share than Lisa due to their respective roles and contributions to the business's growth.

Short-Term Impact:

In the short term, Jatin and Lisa may feel a change in the way profits are shared. This can create tension if the partners do not communicate the reasoning behind the ratios.

Long-Term Impact on Partner Relations:

In the long run, this distribution can affect their views of their roles and value within the business. An increased share for Jatin might change the way he makes decisions and assumes new responsibilities, while an increasing share in the profits for Lisa should motivate her to contribute even more since the share remains proportionate to her efforts. 

Business Decisions: Now is when the sacrificing ratio becomes relevant because when discussing Smriti's departure, if Smriti was initially allowed 50% of profits, Ahaan is promised 30%. In such a scenario, Jatin and Lisa have to sacrifice 20%.

Exit Strategy Implications:

This is also important for businesses planning for future exits, such as retirement, death, or sale. The rules around the gaining and sacrificing ratios ensure this transition is seamless.

Ultimately, both ratios help set the groundwork for transparent partner relationships, fair decision-making, and sustainable business growth, allowing for smoother transitions.

Concluding Remark

Please note that both sacrificing and gaining ratios are specific to partnership accounting. It ensures a fair and equitable distribution of profits and losses among the partners. The calculation of both ratios may vary based on the specific circumstances and terms outlined in the partnership agreement.

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