So What is Profit First? 

The Profit First Formula

The GAAP (Generally Accepted Accounting Principles) formula for determining a business’s profit is Sales – Expenses = Profit. It is simple, logical and clear. Unfortunately, it does not work to make you profitable.  It only reports numbers in a way consistent with a reporting model…not a profit or success model. The formula, while logically accurate, does not account for human behavior. In the GAAP formula, profit is a left-over–something that is hopefully a nice surprise at the end of the year. Unfortunately, the profit is rarely there and the business continues on check-to-check survival.

Sales – Expenses = Profit

Sales – Profit = Expenses

With Profit First you flip the formula to Sales – Profit = Expenses. Logically the math is the same, but from the standpoint of the entrepreneur’s behavior it is radically different. With Profit First, you take a predetermined percentage of profit from every sale first, and only the remainder is available for expenses.

Parkinson’s Law

Author and historian C. Northcote Parkinson theorized that our demand for a resource increases to meet the supply of it. That is why when we are given two weeks to do a project it takes two weeks, and when we are given eight weeks to do the same project it takes eight weeks. That is why when given $1,000 to complete our work we get it done with $1,000 and when given $10,000 to complete the same work, it takes $10,000. Profit First makes Parkinson’s Law an asset. By taking profit first the money available for expenses lessens, and we are forced to find ways to get the same things done for less money.

A History Of Success

Admittedly, Profit First is nothing new.  It is the application of the time tested and world’s greatest financial mechanism “pay yourself first” applied to entrepreneurship. Just as wealthy people know to pay themselves first and then use the remainder for expenses, Profit First teaches us to take our profit first and then use the remainder to run the business.  The 401K retirement plan has been the greatest savings mechanism in US history, because of this powerful “pay yourself first” premise.  Profit First is already proving to be the greatest profit generating mechanism in the history of business, because of this same powerful principle. So while Profit First is nothing new, it is truly unique. And it is truly effective.

Bank Balance Accounting

Most entrepreneurs don’t have the time or gumption to read the different accounting statements necessary to manage the financial aspects of their business. Theoretically you should review and correlate your Income Statement, Balance Sheet and Cash Flow Statement monthly (or more frequently), but few entrepreneurs do. Most resort to “bank balance accounting,” where we check our bank balance every day and make financial decisions based upon what we see. Per Parkinson’s Law, we consume what we see in our bank account. Profit First encourages the entrepreneur to continue “bank balance accounting” by first allocating money to profit (and other accounts) so that the entrepreneur sees the actual portion of deposits that are available for expenses and they automatically adjust their spending accordingly.

Don’t Change Habits, Leverage Them

Many entrepreneurs try to force themselves to become better at accounting and to become more disciplined in their fiscal management by pure willpower. But just like a muscle, willpower can be drained. And in a moment of financial stress or bigger than expected expenses the entrepreneur will break their own fiscal rules and spend the money they have. The Profit First principle does not try to change your habits (that is nearly impossible to do), Profit First works with your existing habits. By first allocating money to different accounts, and then removing the temptation to “borrow” from yourself, your business will become fiscally strong and you will benefit from regular profit distributions.