There is no such thing as a silver bullet in business. Overnight success isn’t real. Businesses that truly succeed are the result of incredibly hard work. Successful businesses not only have a great product or service that people love, they’re also able to generate profit that allows them to continue to deliver with the highest quality while fairly compensating their team and themself. Implementing the Profit First Method allows this type of success to be a reality for you and your business. The Profit First Method was developed by Mike Michalowicz. In his book, Michalowicz demonstrates a novel way of operating your business, focusing on ensuring profit.
What is the “Profit First” Method?
The traditional way of thinking about profit is:
Sales – Expenses = Profit
The Profit First Method doesn’t leave profit for last (hence the name), rather calls for taking a profit separately from dealing with expenses:
Sales – Profit = Expenses
The Profit First Method reimagines cash flow management by changing your approach to profit. We usually think of profit as the output of our business. In the Profit First Method, profit is an input: It’s what we have in the bank. Our expenses become the output.
Your business is on a budget. The Profit First Method calls for a business to follow your budget and also be sure that as an owner you’re taking a profit before you spend on expenses.
The result is twofold:
- An accurate understanding of where and how you’re spending your money.
- More money in your pocket.
How does the “Profit First” Method work?
Putting the Profit First Method into practice will require a mindset shift. The method calls for taking profit out of cash before paying your expenses, as opposed to paying yourself with the leftovers after taking care of expenses. You’ll need to create a system where you transfer predetermined percentages of your cash deposits into smaller separate account buckets such as: profits, taxes, operating costs, owner’s compensation and revenue.
The amount you put into each account is calculated by your Target Allocation Percentages (TAPS). Your Current Allocation Percentages (CAPS) is how you’re spending your Real Revenue now. These are known as the “Profit First percentages”.
Profit First Percentages Explained
The great thing about the Profit First percentages is that they are a window into your business financials. Current Allocation Percentages (CAPS) give you a clear picture of how you’re allocating your finances amongst income, owner’s compensation, operating expenses, profit and taxes. This is your Real Revenue now. Target Allocation Percentages (TAPS) are where you want to split your financials to increase profitability, cash flow and overall business growth. This is where your Real Revenue will go when you’re operating profitably.
When you put the Profit First allocation percentages to work, your aim is to (slowly) move from CAPS to TAPS.
Mike Michalowicz created this Profit First chart to help determine what your business’s target allocations should be based on your real revenue range.
Source: TAPS Chart by Mike Michalowicz from paultlong.com
What are the Profit First Accounts?
There are five Profit First accounts. They are:
- Income: an account containing your earnings.
- Operating Expenses: an account for all of your business expenses like hardware, office supplies, travel and marketing. This is where you can take a hard look at your business and determine if these expenses are necessary or not.
- Profit: an account to use for debt reduction, emergencies and your bonus. This is where the method shines because the Profit First formula exists to generate profit!
- Tax: an account for the taxes you’re responsible for paying.
- Owner’s Compensation: an account for your after-tax salary. Yes! You need to pay yourself.
In order to track your TAPs, you’ll need these five accounts. Once you have these Profit First accounts, you’ll distribute the funds amongst them. Lili enables the implementation of the Profit First method by offering the ability to open multiple accounts, explained further below.
Using the Profit First Formula and Opening PF Accounts with Lili
To start putting the Profit First formula into action, you’ll first place all of your income into the income account. After that, you’ll want to establish a cadence that works with your schedule to distribute the necessary funds into the Owner’s Compensation, Operating Expenses, Profit and Tax accounts. The book suggests the 10th and the 25th days of each month and you should choose a schedule that works for you and your business.
You’ll use your Profit First accounts to pay your bills. Remember to be sure that each account is used for its designated purpose as outlined above.
Implementing the Profit First method can be intimidating, given the logistical implications of juggling multiple accounts. It’s important to choose a bank that offers capabilities that help make using this method simpler.
Lili is dedicated to ensuring seamless business financial management, and offers a number of the accounts required to implement the Profit First formula. Lili’s business checking account is where your Income and Operating Expenses will be housed. The profit account aspect of the method is addressed by using Lili’s emergency savings bucket, while your Tax account is facilitated by the tax bucket. Finally, and most importantly, Lili enables you to seamlessly deposit your Owner’s Compensation into a separate account dedicated to owner’s pay.