How Profit First Radically Changed My Business

How Profit First Radically Changed My Business

Updated: Sep 6, 2019



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A few weeks ago I picked up a copy of Profit First from the library. Yes, I go to the library 🤓

I actually had it on my wait list for about 3 months (must be a popular book)! By the time it came available I actually had this weird passive-aggressive moment where I was like, "Nah I don't want to read it anymore. I put it on my list 3 months ago, so I don't even care now. I don't even remember why I had it on my list in the first place."

Yeah...I literally said that to myself lol. Anyway, I'm glad I came to my senses and decided to go and pick it up because in 1 week this book changed not only my business but also my life with finances.

If I had to sum up this book in one word, it would be "Wow".


I devoured this book in less than a week and started putting it into practice immediately.

This is not "another business book", I promise you. I've read countless business books and this is an incredible breath of fresh air.

Mike (the author) has such a wonderful, conversational and humorous tone that it made the book easy to consume. I mean, we're talking about really serious stuff here - the financial health fo your business. So the lighthearted tone makes the conversation way easier. And really, the book did feel like a conversation. Mike is an entrepreneur himself, so it's like he's inside your head. He knows all of your entrepreneurial idiosyncrasies, especially when it comes to managing your business finances and knowing that you'll put off taking action.

The number one thing I absolutely loved about this book was that he asks you to take action - right away - multiple multiple times throughout the book.

Us entrepreneurs are so good at consuming tons of information and never doing anything with it (or maybe that's just me?). So this was the first book that got me off my butt - immediately.

So What is Profit First?

Profit First is a book written by Mike Michalowicz. He is also the author of the Toilet Paper Entrepreneur. You can read more about him on his website, but "basically" he is an entrepreneur just like you and me. He's started 3 different businesses and learned a lot about (a lot of things really) related to small business. He's had both failures and successes (massive) which lead him to where he is today - and which also lead him to write this book (and a few others).

The premise behind Profit First is this:

Most businesses see accounting as Sales - Expenses = Profit

Mike sees things a little differently Profit - Sales = Expenses

This totally turns everything on its head. And the more you get into the book, the more it makes sense.

Have you ever heard of Parkinson's Law?

Mike references this law as it relates to our business finances.

Parkinson's Law states: "work expands so as to fill the time available for its completion."

In other words, if you have 7 days to get something done, you'll use that full 7 days to do so.

So in the example of traditional accounting, Sales - Expenses = Profit, you'll generally use up most of your Sales on Expenses and then take whatever is left as your Profit. << which probably isn't much.

Mike is saying no no no, take your Profit first (get it) THEN subtract the Sales and what is left over will pay your Expenses.

What does this mean?

This means that you'll be forced to take an honest look at your expenses (employees, overhead, software, subscriptions, etc.) and decide what needs to be cut.

Many expenses a business has are unnecessary. With the Profit First method, if you don't have enough dough left over to pay all of your existing expenses - you better look at cutting some out.

The First Step - Setting Up Your Bank Accounts

The first thing you do with Profit First is set up 5 specific bank accounts. This is how you will organize your money so you know what's allocated to what. No more spreadsheets or "it's all in my head math".

Here are the accounts:

1- Profit (checking)

2- Income (checking)

3- Owner's Comp (checking - gets checks and/or a debit card)

4- OPEX (Operating Expenses) (checking) 5- Tax (checking)

*These will be set up at your regular bank

Then, you'll create two more accounts at a secondary bank NOT your regular bank:

1- Profit (savings)

2- Tax (savings)

If you're familiar with Dave Ramsey, you can think of this like the envelope system - but with bank accounts.

First, I'll explain the 5 main accounts, and then I'll tell you why you set up two additional accounts at a separate bank.

At your main bank, you've got 5 accounts and here's the flow:

- All deposits come into the Income account

- Twice per month, you will allocate a percentage of whatever is in the Income account to the other accounts: Profit, Owner's Comp, OPEX, and Tax.

At your secondary bank, you've got 2 accounts:

- When you make your twice a month allocations, all of the money in your Tax and Profit account at your main bank is transferred to the corresponding accounts at your secondary bank.

Here is where this is so important. Mike knows you because he's done the things you've done. He's done the spreadsheet and "it's all in my head" accounting. He also knows that if you see that money sitting in your Profit and Tax accounts every day - you are bound to steal it.

Steal it? Yes. If you take money from that Profit account or Tax account, you're either stealing from yourself or the government - ouch. I know, that one hurt me too. I'll be honest - I've spent my tax money so many times and decided I would "figure it out" when taxes came around. After all...I had months to get the money together. << SO glad I'm done with that!!

So while it might seem cuckoo to have all these bank accounts AND THEN two more at another bank - this is exactly why. You have to transfer that money right away. Out of sight out of mind!

The Second Step - Figure Out Your TAP

TAP = Target Allocation Percentages

Mike has a super handy-dandy table called the Instant Assessment that will help you figure these out. The whole chapter on TAPs is also incredibly helpful with the examples he gives.

This is where you will determine the percentages for your Profit, Tax, Owner's Comp, and OPEX accounts (this is what you transfer 2x per month).

Pro Tip: Mike mentions this many times throughout this chapter and I have to echo it. 1) Don't overthink this part! And 2) Don't go all out with your profit percentage at the start.

In Figure 1 of the Instant Assessment, he lists ideal percentages for each account based on a real revenue range. For example, if your business is in the $0-$250k range, the ideal Profit percentage to achieve would be 5%. But he (and I both) highly recommends starting out with 1% for Profit and increases it by 1% every quarter. The reason being is if you go all out at 5% at the start and your business can't cover it, you're going to have to take money from somewhere else - and you can't do that.

The Third Step - Pay Yourself (and your expenses)

Ok so now you understand the bank accounts you need to set up, and how the twice a week allocations work.

So how do you pay yourself?

For this example, we'll say that I do my allocations on the 10th and the 25th.

Here's the breakdown:

1- Profit (transferred to the secondary bank)

2- Income (this should be 0 after all allocations)

3- Owner's Comp (MY pay - goes straight into my pocket)

4- OPEX (use this to pay all of your expenses)

5- Tax (transferred to the secondary bank)

What about bonuses?

Bonuses you say? Yes! Bonuses!! 🤗

At this point you might be wondering...ok I get that the Tax account at the secondary bank sits there until I need to pay my taxes. But what about the Profit account, what do I do with that money?

At the end of every quarter, you take 50% of whatever is in your Profit account (at the secondary bank) and that is your bonus. Woohoo!! Awesome right?

The other 50% stays there, Mike get into this in the book with what you can do for that remaining 50%. There is an "Advanced Profit First Method" once you've gotten the basics down. So I won't go into detail on that.

The only caveat to this bonus is that you CANNOT put it back into the business. If you use it to buy something for the business or to cover an expense, then you're doing it wrong. Especially if you're covering an expense - you have to go back and fix your percentages. The reason for this is that so many entrepreneurs are a victim of burn out. You have to reward yourself - better yet, the business should be rewarding you!!

The Fourth Step - Look At Your Accounts Daily

Once you've got all of this setup, you'll log in to your bank account (main account) daily.

At a glance, you'll be able to tell the financial health of our business. You'll also be able to tell if you might end up short that month - so you know you'll need to make a few more sales.

Mike calls this Bank Balance Accounting.

The Fifth Step - Take Action!

I'm going to take a page from Mike's book (literally and figuratively) and challenge you to take action on this RIGHT NOW.

Seriously, get the book, read it and do what he says - 100%.

If I can do this, so can you!

Listen, I am NOT a numbers person. Anything math gives me the heebie-jeebies. And honestly, if I even attempted to understand the things my accountant says I might end up crying in a corner.

I'm not exaggerating when I say I read this and implemented it in one week. If you do anything for your business (and yourself) this year, DO THIS.

Resources

- Buy the Profit First Book

- Mike Michalowiczes website

- Profit First Resources (on Mike's Site)

- Handy TAPs spreadsheet I found by The Lazy Source

I'd also recommend checking out Mike's other books!

- The Pumpkin Plan, Surge, The Toilet Paper Entrepreneur

I loved the Pumpkin Plan and Surge! Haven't read TPE just yet!

Until next time...Hang Loose! 🤙🏻

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