Introduction
No business owner wants to work crazy hours and pay themselves little money. That’s just a given. Yet many entrepreneurs find themselves in that very position when they open their own business. They have a great company, they’re working hard, and yet… their profits are nonexistent. Most people think they just need to work harder when that happens. But there’s actually a solution that’s much simpler — and better for your wallet! It’s called the Profit First Method and it’s an accounting hack that has transformed businesses across the country for the last 8 years. But just what is the Profit First Method? And what do you need to know about it? In this article, we aim to answer all your questions and offer a primer on all things Profit First. To make it as easy as possible to follow, we’ve broken this article down into three main sections:
- What is the Profit First Method?
- Does the Profit First Method work?
- 4 Tips and Reminders for Implementing the Profit First Method
Let’s get started.
What is the Profit First Method?
The Main Idea
The Profit First Method is a behavioral accounting strategy developed by entrepreneur Mike Michalowicz and publicized in his book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine.
As the name suggests, the Profit First Method counsels business owners to flip the traditional accounting formula and deduct profit before expenses.
The traditional approach:
Sales – Expenses = Profits
The Profit First Method:
Sales – Profits = Expenses
Doesn’t sound too revolutionary, does it? Don’t let the simplicity fool you. Think through what this means for your business.
Typically you pay off all your bills and fees and pocket whatever is leftover. But as most business owners know, there’s rarely much leftover. As a result, you have to take a pay cut just to stay in the black. Your owner’s pay becomes an afterthought… even though it was one of the main reasons you went into business in the first place.
But when you use the Profit First Method, your priorities change and then so do your behaviors. As soon as your business makes money, you take a portion of that and put it aside as profit. That way, you’re automatically profiting the same amount every single month. What about expenses? Well, with this new formula, your expenses get paid with the leftovers. And while you might at first worry about not having enough to pay the bills, what actually happens is that you end up minimizing expenses. You spend less money because there’s simply less money to spend. Crazy, right?
(If that still seems a little murky, think of it in terms of project management. If you have a week to finish a project, how long will it take you to complete it? Usually a week — even if that’s because you procrastinate until the night before. But if you only have two hours to finish the same project, how long will it take you? Two hours. You find yourself working as efficiently as possible and somehow the work goes by much faster. This is a well-known psychological phenomenon called Parkinson’s Law.)
How it Works in Your Business
The rest of the Profit First Method supports this core idea. Businesses following the method set up multiple bank accounts. Typically you start with five:
- Income
- Profit
- Owner’s pay
- Tax
- Operating Expenses
These different bank accounts keep your money organized and streamline your cashflow. You start with your income account and from there schedule transfers into the other accounts. With your money in separate accounts, you’re never tempted to steal from your owner’s pay to afford expenses or vice versa.
Profit First advises you to allocate specific percentages of your income into each account. (More on these percentages later.) While those percentages may have to adjust as your business grows, having a plan and some measure of consistency in place will keep your finances healthy.
Does the Profit First Method Work?
If you’re a business owner reading this article, you’re likely interested in one thing above all: results. A system can sound nice, but it only matters if it can work on a practical level.
That’s where the Profit First Method excels. The system is fairly easy to set up and doesn’t require an advanced accounting degree to maintain. Instead, it helps you make small, sustainable changes to the way you handle money. Nearly any business can implement these changes and once they do, they’ll see consistent results.
That has certainly been our experience at Every Single Bean. As a Profit First Certified master, we’ve helped medical practices across the country rearrange their finances according to these principles. Our clients have discovered new levels of profitability and been freed to scale their business.
We hear many testimonies of successful ‘Profit First’ naturopathic doctors. One client, Dr. Matt Hernandez, said, “I had no game plan for how to grow my revenue or how to even start. Now I feel more confident in my skill set as a business owner. I’m much happier too because I’m paying myself significantly more!” Or take Dr. Kelly Han, who writes, “[The Profit First System] relieved an enormous amount of stress and anxiety while giving me more control of my business.”
We recommend the Profit First Method because we’ve seen it work firsthand for so many business owners. And we believe it can work for you too.
4 Tips and Reminders for Implementing the Profit First Method
1. Stick to Your Allocation Percentages
An allocation percentage refers to the percentage of your business income you put toward different costs. The Profit First Method divides allocation percentages into four areas: profit (5%), taxes (15%), operating expenses (30%), and owner’s pay (50%). You can tweak these percentages to fit what makes sense for your business, but here’s the key– prioritize your profits, and do everything you can to ensure your pay is the biggest chunk of your income.
2. Think Ahead
Consider your plans for future business growth. What operating expenses will that growth entail? Remember that your goal is to strategically allocate your operating expenses before you cut into your pay. So, think ahead. If you know that you need to make a big purchase in the coming months, such as new equipment, consider how you can minimize other operating expenses.
3. Use Separate Bank Accounts
Bank accounts help you order your cash flow. Categorize your income into different accounts to simplify your expenses. Start with a general account for your income. This account will include every deposit to your business, and funds will flow from it into other accounts. Profit First recommends 4 more:
- Profit
- Owner’s Pay
- Taxes
- Operating Expenses
4. Consistency is King
Your revenue will fluctuate from month-to-month, but that doesn’t mean that your pay has to. Pay yourself consistently during the highs and lows of your business. This creates sustainability for you and your business. When business is booming, don’t cut yourself a larger paycheck. Rather, stick to your allocation percentages and fuel your operating expenses. This will ensure you have cash reserves during months that are a little thinner.
Need Help Getting Started?
So far we’ve explained the basics of the Profit First Method and even offered a few tips for setting up the system in your business. If you follow the general principles we’ve outlined, your business will be primed for growth and profitability.
But like all financial matters, the Profit First Method can take some time and energy to sort through. The clients we work with at Every Single Bean find that even this simple strategy takes them away from what they do best — caring for their patients. That’s where we come in. We provide expert bookkeeping and CFO services so that the business end of your practice never gets in the way of caring for patients.
We love setting doctors up for financial success. If you’re interested in getting help with the Profit First Method, schedule a complimentary call with our team. We’d be happy to answer your questions and discuss how your business can grow.