Easy Guide to Profit First and the Benefits for your Business
You may have heard about the financial management system called Profit First, and thought that it was a myth.
The idea of paying yourself first and not only keeping your business alive, but enabling it to grow, does sound a little unbelievable – I admit. But it isn’t a fantasy – it is a valid and workable way to encourage healthy business growth.
It is definitely not a myth – but it does take some commitment. Let’s have a bit more of a look at what Profit First means and what the benefits of following the Profit First system could mean for your business.
Ironbark Industries Bookkeeping’s Easy Guide to Profit First and the Benefits for your Business
What is Profit First?
Profit First is a money management system developed by Mike Michalowicz and first detailed in his book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine.
Profit First works on the idea that modern businesses and start-ups need to look into a more contemporary way of doing business, because the old-school methods of accounting aren’t working. Traditionally a business will manage money on the following foundation:
Income – Expenses = Profit
Businesses more naturally use all of the money available to cover their expenses and keep the business running smoothly. Expenses have a way of expanding to fill the amount that you have in the bank, meaning that you are unlikely to make a profit.
According to Profit First, if you have less money to work with then necessity forces you to reduce your costs and make things work.
The Profit First model instead works on this foundation:
Income – Profit = Expenses
This works by removing your profit, wages, taxes, and any money needed to grow the business aside first, before paying any day to day expenses. The business should always take a profit and earn a wage regardless of the size of the income.
The business needs to reduce the cost of its expenses to fit within the amount that is left – which forces business owners to get aggressive and creative about how to reduce their bottom line. If you are forced to work within a small cost limit, then you will have to stick to it – right?
Even expenses that you thought were fixed can often be reduced. The shift in thinking puts finding practical solutions to cost-cutting at the forefront of your mind. And then with practice, this will become a habit.
You need to have a reasonable idea of your wage and the amount of profit you put aside as well.
Profit First focuses on:
· Paying wages, tax, and profit to grow the business first
· Paying expenses with what is left
· Aggressively reducing expenses and sticking with these limitations
· Implementing strategies to increase profit margins
· Developing more efficient processes and making difficult but necessary decisions sooner
By building profit, you are building equity in your business.
Profit First works by establishing five separate bank accounts:
· The Income account is the account where all of your money is deposited into. You then use this account to do your regular weekly/fortnightly/bi-monthly etc % distributions to the other accounts.
· The Profit account which has a predetermined % of your income transferred on a regular basis. This is saved up until the end of the quarter where you will then take a Profit Distribution and use the funds for reducing debt.
· The Tax account which is just for paying tax and superannuation. Again, a predetermined % of your income is transferred on a regular basis. This money is to go towards your personal & company taxes.
· The Owner Pay account is where the % allocation for your wage is paid from. This money is also to pay towards your Superannuation.
· An Operating Expenses account is the final account to transfer your % into. This is the only account you can work with to pay for everything else.
What are the Profit First benefits?
Profit First works for many businesses, but requires a shift in mindset. Your primary focus needs to be on reducing expenses or removing them altogether by forcing you to work within stricter limitations.
It can reduce stress by giving you peace of mind that your wage is coming in, tax and super will get paid, and there is a healthy profit growing in the bank, building equity in your business. You don’t have to worry about the basic survival of your business.
You do however need to face up to hard facts about how to reduce costs, and get good at closely analysing all the ways you can make this happen. It can mean letting go of low paying clients or staff who aren’t absolutely needed, or removing products or services that you love but that aren’t paying their own way.
It removes the stress by removing the sentimentality – there is no room for niceness here. But there is a comfortable future and daily peace of mind.
Can any business follow Profit First?
Any business, regardless of size, can follow Profit First – you just need to be willing to commit to the mindset and work at reducing or removing expenses.
More and more businesses of all sizes and in all industries are converting to this way of managing their money, and are happily finding that it works for them.
The way the Profit First book is laid out makes it easy for people who aren’t trained in bookkeeping or money management to implement the system in their business. You don’t need to be an accountant or have things explained to you by one to get on board.
This makes the system accessible to all sorts of businesses including startups and solo-entrepreneurs. It can be a good way to work from the very start of your business, but can be implemented at any stage if the way you’ve been doing things so far isn’t working.
If the Profit First system is sounding pretty good by now and you’d like more information on how it could work for your business, give us a call!