You started your business expecting to take a profit after all your hard work. If you’re in a position now when you are still struggling to see sustained profit in your business, then this system is for you. The Profit First cash flow system organizes and manages your finances in such a way that will increase profits, cut expenses, and reduce the stress of operating a business!
Profit First Basics: What exactly is Profit First?
Profit First is a cash flow management system developed for small business owners by small business owners. It was founded by Mike Michalowicz, and asserts that you, as the owner, should be rewarded for your hard work and take your profit first! It takes many of the strategies that Dave Ramsey suggests for personal finances, and applies them to business finances.
Profit First is a system that splits your revenue into separate business accounts (Profit, Tax, Owner’s Comp, and Operating Expenses). You regularly allocate a certain percentage of your revenue into each of these accounts, starting with Profit, and watch as the balances grow.
After implementing the system, you will immediately see a growth in Profits, be better prepared for your tax liabilities, and you will learn to cut expenses across your business. See how this business owner achieved increased profits, and was able to save 3x the amount she owed for taxes using Profit First.
So how does it work? The psychology of 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’s a lie. The formula, while logically accurate, does not account for human behavior. In the GAAP formula profit is a left over, a final consideration, something that is hopefully a nice surprise at the end of the year. Alas, the profit is rarely there and the business continues on its check-to-check survival. With Profit First, the GAAP formula of…
Sales – Expenses = Profit
changes to….
Sales – Profit = Expenses
With Profit First you to flip the formula to Sales – Profit = Expenses. Logically the math is the same, but from the stand point 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 also 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.
Bank Balance Accounting:
Most entrepreneurs don’t have the time or gumption to read the different accounting statements necessary to manage the financial aspect 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. If all your money is in one pot, that encourages us to spend it all, leaving nothing for Profit, much less other things like tax or debt.
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. It creates multiple pots so that you can spend everything in your operating expenses account without having to worry about taking a profit, because you’ve already taken it!
Leveraging Your Habits:
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.
Watch this 2-minute video to learn the basics of how the system is implemented, then read on to learn the specifics of Profit First implementation!
How do you implement the system?
Profit First is best implemented in your business using a certified Profit First Professional. We have achieved Mastery level certification in teaching Profit First implementation to small business owners.
Here are the basics of how it’s done:
1. Set up the 5 key bank accounts (Income, Profit, Tax, Owner’s Pay, and Operating Expenses).
You can rename your current business account as Operating Expenses if you wish.
The Profit and Tax accounts should be savings accounts, and you may want to even open these two at a different bank to make it harder to steal from these accounts to pay bills.
2. Determine your TAP (Target Allocation Percentages
You will do an Instant Assessment for your business to determine what percentage of your income should be going into each account (We can help you do your instant assessment). These are called your allocation percentages.
3. Perform your allocations
All deposits/receipts should be going into your income account. On a regular schedule (we suggest the 10th and 25th of each month), calculate your percentages and transfer the amount into each of the other 4 accounts. The amount will change every time because your revenue will vary (we have a tool that automatically calculates the amount for each allocation).
4. Pay Your Bills with what remains in Operating Expenses account
What is left in your operating expenses after each allocation is what you have to pay all your operating costs until the next allocation. This allows you to set aside money for things like Profit first, and reduce your spending on unnecessary expenses. If you don’t have enough to buy for something, this forces you to be creative and find other ways to pay your bills or cut them down.
5. Take a quarterly profit bonus
Each quarter, you will take 50% of your profit account and pay yourself as a Profit Distribution! This is a bonus to you as the hardest working employee in your business and a reward.
Learn more about Profit First here, and schedule a free profit call with us to learn how it can be implemented in your business!
Get help from a Certified Profit First Professional
It is highly recommended to use a Profit First Professional to help you implement Profit First in your business. We are expertly trained and certified to correctly determine your allocation percentages, and we can help you understand your financial reports, activity, and cash flow in a way that regular bookkeepers or CPAs cannot. Our goal and focus is YOUR business’s profitability, and we are committed to helping you achieve permanent profits in your business.
We at Better Biz Info offer a free Profit call to discuss your needs and talk about how Profit First can be implemented in your business. Schedule your Free Profit call today!
