Hey Square Readers,
We hope you’ve started to dive into reading Profit First by Mike Michalowicz!
As we begin, let’s first lay the foundations for the Profit First plan by looking at what profit actually is, why it’s important to be profitable, and the reasons why so many businesses don't reach profit.
Why Profit is Important:
The author writes, “What I’ve found is that the fastest, healthiest growth comes from businesses that prioritize profit. And it is not because they plow money back into their businesses. Businesses that plow back their profits aren’t truly profitable; they are just holding money temporarily (feigning profit), then spending it, just like any other expense.”
The author lays out the difference between Accounting Profit and Real Profit. He gave the example of his accountant giving him his annual statement showing that he made $15,000 in profit, but that he spent it on expenses. Technically there was profit, but in reality, if you spend it on the business, is it really profit?
Real profit is operating without debt, and maintaining continual cash reserves after all of your expenses. Profit can be used to distribute to owners/shareholders, to fund the business in case of emergency, or in a select few other cases.
Why Your Business is Not Profitable:
The author talks about the Survival Trap, where business owners go through cycles of:
- Being in a crisis period of having very little money in the business accounts
- So they try a lot of different strategies to bring in extra money
- Which brings them into a period of big sales and income
- So they end up spending it all to pay expenses
- Which brings them back into a crisis period with very little money
Not only does this make your business unprofitable and adds extra stress to your life, it also pushes your business further away from its actual vision and purpose.
Why Profit First:
One of the main goals of Profit First is to be able to avoid this Survival Trap. By enacting Profit First, businesses can end up being consistent with the amount of money that they have, and also by making business decisions that keep you in line with the vision of your business.
This is done through being aware of how you spend your money, putting money aside for each of your spending and savings goals, and cutting down on spending along the way.
The author says, “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. If you find that you can’t pay your bills after taking your profit first, you must address all those points and make the fixes.”
Next week we’ll dive into the heart of Profit First: the core principles and the first action steps of how to enact the Profit First plan!
We’d love to hear your answer in the comments:
- What does profit look like for your business? What do (or would) you do with your business’s profit?
- Have you been in the Survival Trap? What have you done (or are currently doing) that has brought in more money but not profit? Which of them would you stop if you were profitable?
Feel free to share any other thoughts you have about this book. We can’t wait to hear your thoughts in the comments below!
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Happy reading,
Pesso
That first question is a tough one, only because it has two answers for me. Profit for us is whatever is “left over” after the month is closed. But it is complicated by the fact that it is NOT what is shown on the bottom line of my P&L. Since I am in the process of freezing and paying down debt, there are cash-eaters out there that only show up on a Balance Sheet and/or Cash Flow Report. After all, the process of paying down debt (excluding interest which is reflected on a P&L) means I am paying off something I’ve already borrowed and spent. This makes my P&L look so much better than it actually is in real life. So, I’ve decided to use more of a home-grown cash flow statement which is my P&L profit/loss less any cash used to pay down debt balances.
Honestly, I’ve never understood the benefit of a P&L bottom line precisely because of this issue. Sure, it tells taxing authorities how much I might owe them, but otherwise it is a rather useless number. (As a side note, this is yet another reason why debt should be avoided at all cost. It not only costs us money in interest and fees to borrow, but then it impacts our cash flow and ultimately our real profit for too long a period of time.). Anyway, by the end of this season, I plan to have reduced my debt by 40-50% which will be amazing it if works. Obviously, the business can handle that debt load as it exists now, but it shouldn’t need to do so. There are better things I can do with that cash, especially putting it in my own bank account since (as a pass-through LLC) I’ll be personally paying the taxes on it anyway.
What do I do with profit as shown on a P&L? Pay myself first (Piper’s is a partnership/LLC and so I can’t pay myself via payroll), continue to pay off my now-frozen debts, save for the off-season bills and unexpected expenses and hopefully have a little left over to either pay myself more or plow a little back into the business if needed.
I’m trying to imagine any small business owner who hasn’t experienced the Survival Trap numerous times! In my case, the pandemic shutdowns revealed to me the folly of chasing larger and larger gross sales hoping that this would eventually reach a tipping point to amazing profit and wealth! As has already been said by others here, the pandemic taught me that more and more sales from insane diversification and expansion was not the answer and, in fact, was the problem.
It took us a while to completely learn that lesson, however. After the shutdowns, we exited the food business and that was the best decision we ever made. Post-pandemic, the food business is too expensive and getting more so every day. To truly price menu items that ensure a living wage for all employees without tips (which is where the business is heading, folks!) means that eating out can never be viewed again as something that is inexpensive. It can’t be inexpensive, and it shouldn’t be inexpensive. But, after having learned that lesson, we thought that “maybe” we could make a go of adding a new product line in “adult” shakes and such. It was a great idea but in the end it was yet another diversion from our business model. Getting rid of it eliminated $30k in gross sales and $40k in expenses (with me being the full-time bartender!). You can do the math. We more than made up the reduction in gross sales by the increase that came from focusing on our core business model, and in this case the expenses are so much less.
Besides the obvious of being able to pay ourselves, profit is important because without it there is no point in owning a business. That is just hard, cold reality.
