As weโre getting deeper into reading Profit First by Mike Michalowicz, letโs get deeper into the material. Last week we talked about the basics: why profit is important, and some of the reasons why businesses fall into the Survival Trap and stay unprofitable.
Now, letโs dive into the core principles and first action steps of this strategy of ensuring that your business becomes truly profitable.
But first, a major caveat and expectation setting: you canโt just implement the steps of Profit First and expect to magically be profitable. The steps will help show you what you need to do in order to be profitable. You will probably need to cut expenses. You may need to increase sales. You will need to work smarter. The steps of Profit First can help show you how to do that, and enable you to systematically put aside your profit. But you will need to do work outside of these steps.
What is Profit First:
The author says, โIโm simply asking you to remove the profit first, and operate on less.โ
But thatโs easier said than done. Taking profit first is not just a mindset change, but rather also a physical systems change. The plan is to put systems in place to make you get used to having less to spend on your business, securing more profit.
Here are the 4 Core Principles of Profit First
- Use Small Plates
- Our needs grow to fit our means. All expenses feel necessary, especially when youโre used to having enough money to pay for them. But when you donโt have that money, you tend to get more creative and can get by with less.
- โWhen less money is available to run your business, you will find ways to get the same or better results with less. By taking your profit first, you will be forced to think smarter and innovate more.โ
- Serve Sequentially
- According to the idea of โPrimacy,โ what we see or do first sets our expectations. If you pay your expenses first, expenses will be the most important thing. When we think profit first, profit becomes most important. This is done by first setting aside money directly from our income into accounts for profit and each type of expense.
- โAlways, always allocate money based upon the percentages to the accounts first. Never, ever, ever pay bills firstโฆ And if there isnโt enough money left for expenses? This does not mean you need to pull from the other accounts. What it does mean is that your business is telling you that you canโt afford those expenses and need to get rid of them.โ
- Remove Temptation
- If we see money somewhere, weโre very likely to dip into it and fall back into the Survival Trap. Solve that temptation by taking and hiding that money. Make it inconvenient to look at it, and even more difficult to use it.
- โMove your PROFIT account and other โtemptingโ accounts out of armโs reach. Make it really hard and painful to get to that money, thereby removing the temptation to โborrowโ (i.e., steal) from yourself. Use an accountability mechanism to prevent access, except for the right reason.โ
- Enforce a Rhythm
- If the money in your bank accounts are inconsistent, youโll be inconsistent with your spending. If youโre inconsistent with your spending, itโll be a lot harder to secure profit. Take control by making transfers and payments twice a month, or automatically.
- โDonโt pay only when there is money piled up in the account. Get into a rhythm of allocating your income, and paying bills twice a month so that you can see how cash accumulates and where the money really goes. This is controlled recurring and frequent cash flow management, not by-the-seat-of-your-pants cash management.โ
How to Enact Profit First:
From those Profit First principles, the author lays out the first steps of implementing them in your business. You can also check out the Profit first One-Sheet for a simple instruction guide.
Step 1
If you just want to get a taste of the Profit First process, this is the first step the author recommends you follow in order to make sure you can put aside profit first.
- Open up a separate Profit account.
- Use the same bank you currently use for your business and open a second Checking Account that youโll use to store away your profit.
- Use the account nickname feature to call this account PROFIT.
- Transfer 1% of your current bank balance into it.
- Each time you get a deposit or income from sales, transfer 1% of it to this account.
- You can set up automatic transfers, or just calculate and transfer it manually.
- Donโt touch this money.
- Michalowicz says, โYou have โseededโ the account. Donโt touch it. Never transfer it. Just let it sit for now.โ
The author writes, โYour goal for now is to get started immediately and decisivelyโฆ But something magical will happen. You will start proving the system to yourselfโฆ You will have a flavor of how powerful it is to reserve your profit in advanceโฆ The goal is for you to realize that this unfamiliar process of taking your profit first isnโt so scary after all. Then once you are digging the Profit First vibe, you are set for greater success. Because you will be staged perfectly to do the rest of the system, and your heart will be in it.โ
Step 2
When youโre ready to move onto doing more, and following the basic process of Profit First here are the next steps:
- Follow the process in the Step 1 section above.
- Have a total of 5 Checking Accounts
- The goal is to have a total of 5 Checking Accounts to use as buckets. The five accounts are:
- INCOME
- PROFIT
- OWNERโS COMP (COMPENSATION)
- TAX
- OPEX (OPERATING EXPENSES)
- If you already opened a PROFIT account in step 1, then use that. Rename your existing checking account to OPEX. Open 3 new checking accounts named INCOME, OWNERโS COMP, and TAX.
- Set up these accounts according to how youโll use them. Your deposits will go directly into your INCOME account, your personal payroll will come out of OWNERโS COMP, pay your taxes from the TAX account, and all other expenses would come out of OPEX.
- Your income from sales goes into your INCOME account, and you would then transfer all of this money out into each of the other accounts, according to set percentages that youโll determine based on your current spending and goals youโll set.
- โAlways, always allocate money based upon the percentages to the accounts first. Never, ever, ever pay bills firstโฆ Then you pay bills only with what is available in the OPEX account. No exceptions. And if there isnโt enough money left for expenses? This does not mean you need to pull from the other accounts. What it does mean is that your business is telling you that you canโt afford those expenses and need to get rid of them. Eliminating unnecessary expenses will bring more health to your business than you can ever imagine.โ
Step 3
And hereโs the next step of the Profit First plan:
- Follow the process in the Step 1 and Step 2 sections above.
- To meet the โout of sight, out of mindโ part of the Profit First plan, open two Savings Accounts at a separate bank:
- TAX - HOLD
- PROFIT - HOLD
- Any time you transfer money into the TAX and PROFIT checking accounts, then immediately transfer everything from those over to each of these secondary HOLD accounts.
- Set up your allocations and payables to be twice a month, to limit the amount of time you spend working on this system. The author recommends the 10th and 25th of each month. This is when you would transfer money, then pay your bills, then pay yourself according to your established salary.
- Each Financial Quarter, pay your Taxes and then take your Profit.
- On the first day of each quarter take 50% of what is in the Profit Hold account and distribute it to equity holders/owners. This isnโt owner compensation, this is profit sharing. The other 50% stays in the account as your emergency fund. If you have more than a three month emergency fund, you can use the excess to spend on capital gains and improvements on the business.
- Adjust your allocation percentages to get closer to your target goals.
You can also check out the Profit first One-Sheet for a simple instruction guide.
Next week, weโll run the Instant Assessment to see what financial shape your business is in now, and to determine what percentages youโll divide up your income to transfer into each account.
Weโd love to hear your answer in the comments:
- What are your initial thoughts on reading the principles of Profit First?
- Are you going to enact any of these action steps?
- Have you tried this already? What have you felt and seen so far?
Feel free to share any other thoughts you have about this book. We canโt wait to hear your thoughts in the comments below!
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Happy reading,
Pesso
Hey, fellow readers! Iโm going to post this thought here, then ask @Pesso to do me a favor. But, firstโฆ..
As Iโve been working through Profit First, Iโve realized that Square has given us a pretty darn good tool to help us put the principles in action. That tool is Square Savings with its associate Savings Folders. I had already decided to rework my 2024 financial planning to follow the Profit First guidelines. Iโm going to do an experiment for all of 2024 that incorporates Square Savings to do what it does best โ create account(s) that automatically get funds added to them with each sale so that I donโt really miss them.
Iโve create various folders in my Savings dashboard with percentages defined to automatically sequester funds from each card sale I make in 2024. I already ignore what is in savings, having done that all of 2023 to put aside funds for my closed off-season, so I know Iโll be disciplined. Each day, Iโll ONLY transfer what is left in my Square Balance (after savings have been taken out for each folder) and then use that money for my regular expenses. Since Square Savings are out-of-sight-out-of-mind in my day to day routine, I just wonโt miss what is accumulating there!
Weโll see if this experiment works, or not. But if anyone is interested in following along throughout the year as I put it in action โ and to hear the good, bad and ugly โ then Iโm hoping that @Pesso will create a separate thread (better yet another board where I can post multiple topics for the sake of clarity!) and post its link here. That way those that want to follow along and chime in with comments and suggestions can do so. And, if itโs in a separate thread, then we donโt have to clog up this one with stuff and other people donโt want or need to see. Win, win!
I already have a few issues Iโve had to tackle as I set this up for myself. So Iโll share those along with my solutions as soon as I can.
