The Profit First" by Mike Michalowicz book has not only provided me with peace of mind, but has also helped me to pay myself from my business, which as you know, can be challenging in the early stages of a business. So, let's delve into what I've learned from this book and how I've put it into practice in my own business as well as in my clients businesses.
The tagline for Profit First is “Transform your business from a cash-eating monster to a money-making machine.” The main goal is to learn how to make your business profitable and ensure that you're reaping the rewards of your hard work.
As a small business owner, it often feels impossible to pay yourself, and for most startups, all income goes directly into covering business expenses. Michalowicz, drawing from personal experience and extensive research, emphasizes that the typical accounting system is flawed. The conventional formula is Sales - Expenses = Profit. His advice is to flip this equation and prioritize taking your profit first, hence the book's title.
We tend to believe that increasing sales will automatically lead to increased profit, so we convince ourselves that once our sales rise or we secure more clients, we'll finally be able to pay ourselves. However, in reality, when income rises, expenses tend to rise in tandem, and we don't actually see a meaningful return. More revenue doesn't always equate to true business success. Instead of fixating on growth, we should focus on profit, identifying what contributes to it and eliminating what doesn't.
Michalowicz argues that traditional accounting contradicts human nature because, "no matter how much income we generate, we will find a way to spend it - all of it."
Traditional accounting emphasizes sales and expenses, leading to growth in those areas since we tend to invest in what we're focused on. If you consistently prioritize business expenses burnout is more likely.
When you make it a point to pay yourself and acknowledge your hard work, you'll be more motivated to continue growing your business. After all, what's the point if you never reap the benefits of your efforts?
If you're wondering how you can truly grow by setting aside profit first, consider this: what I’ve found is that the fastest, healthiest growth comes from businesses that prioritize profit.
Profit First sparks faster growth because it makes you reverse engineer your profitability. When you take your profit first, your business will tell you immediately whether it can afford the expenses you are incurring; it will tell you whether you are streamlined enough, it will tell you whether you have the right margins.
Michalowicz delves deeply into the flaws of the existing system and how to rectify them. If this piques your interest, I highly recommend purchasing the book and reading it in its entirety. His writing style is very accessible, even for those without a financial background.
What I'd like to cover here are the fundamental principles of the system and how I tailored it for HM Accounting (my own business).
There are four core principles in Profit First, which draw from psychological principles used in dieting and remind me of the cash envelope method that some people use to budget their money.
1. Use Small Plates: Just as using a small plate for food can lead to eating less and potentially losing weight, having less available can lead to more innovative thinking.
Similarly, when you prioritize taking out your profit first, leaving less for business expenses (a smaller plate), you're likely to stop spending in unnecessary ways and become more creative in how you allocate your resources.
When money enters your main account, it serves as a tray for distributing funds to various categories based on the percentages you've established.
2. Serve Sequentially: The first thing we encounter often holds greater significance. When we focus on sales and expenses, profit becomes an afterthought. However, "when profit comes first, it’s the focus, and it is never forgotten." Prioritize taking your profit first, allocate your money based on predetermined percentages, and eliminate unnecessary expenses.
3. Remove Temptation: The principle of "out of sight, out of mind" is powerful. By setting aside profit from incoming funds and putting it away, you're less tempted to spend it on business expenses.
4. Enforce a Rhythm: Establishing a routine helps prevent reactive spending during periods of large deposits or panicking in the face of significant cash flow fluctuations. Michalowicz suggests dividing your funds twice a month, but I personally do it weekly because it works better for me.
Michalowicz suggests setting up five separate bank accounts: one for income, one for profit, one for owner’s compensation/salary, one for taxes, and one for operating expenses. He also advises making the taxes and profit accounts "no temptation" accounts by setting them up at a different bank, but I haven't found this necessary for me. What I appreciate about this system is its flexibility. I set up several accounts under our existing bank account and customized them to suit our needs. Here are the accounts I've set up:
Operating: This is where all our income flows in. I use it to cover all our business expenses and pay the credit card.
Payroll: This is where I set aside money to pay myself every two weeks. While you can choose to pay yourself whatever is in this account, I prefer a fixed salary to provide more predictability to our income.
Profit: Following a tip from the book, we set aside at least 5% of all income. It's been incredible to see how impactful 5% can be.
Tax Savings: This helps to avoid the shock of tax time. It's recommended to set aside about 30-35% of your income for taxes but you should consult your accountant for their recommendation. Over time, you'll also learn what makes sense for your business.
Savings: I'm a fan of saving, as you can probably tell, so I put aside a bit of money from each receipt for emergencies. At the end of the year, I aim to use at least some of this money, either to fully pay off the credit card or make a business investment.
You can evaluate your expenses and spending habits to create your own system for allocating funds. While Michalowicz suggests specific percentages, I established my own based on what works best for my business, and these percentages may evolve over time.
The key is to work towards prioritizing profit. Initially, you may not be able to allocate a large chunk to profit, but as you trim expenses and grow, that percentage should increase.
I use the above in conjunction with my business budget. This system made it straightforward for me to determine how much I could allocate for business expenses. I use the same budget system for my clients which have brought incredible results to their business.
HM Accounting uses the same system, based on the profit First method, in our financial consultations and training services. This is a system that we have personally have tried and tested and seen the results of. We know it will work for you too.
Serious about crushing your profits and gaining control of your finances, book a business finance consultation with us (first one is free) or download our training brochure here for more information.
Also feel free to send us a message or email for more information on our business finance trainings and consultations.
Knowing exactly how much money we have at a glance by looking at our bank account provides me with a great sense of security. It assures me that I can pay myself and still cover all bills. Additionally, it guides me on what to do with our money when it comes in, rather than spending it sporadically
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