Finance

“That’s the way we’ve always done it.” In my former life, working in government, often when someone would suggest a new method, system, or principle which a superior was denying, it would be followed with this line. This way of thinking is why many of our government entities are archaic in processes and not able to keep up with the demands of their constituents. This also shows up in private sector businesses as well, because the one thing business owners dislike more than the way things are, is change.

GAAP or Generally Accepted Accounting Principles have taught us that the flow of money through a company starts with revenue, subtracts expenses, and ends with profit. There is a lot more to GAAP accounting and it has undoubtedly created a standard for business accounting and accountability, however, it has also contributed to many businesses being unprofitable.

Profit First, the book by author Mike Michalowicz, describes a fresh perspective for business accounting, wherein you take your profit first and then each of your expenses, in the order of priority. If this sounds outlandish and if you are skeptical, realize, Mike’s method encourages you to be more profitable. That’s it! His motive is for you to pay yourself and then tighten your businesses expenses to live within the remaining revenue stream. We should all be celebrating this, yet I imagine there are still some furrowed brows at the mere suggestion of such a thing. Stick with me… Your light-bulb moment is coming!

Open your profit account

The first step in implementing Profit First is to create a “Profit” account at your bank and immediately fund it with 1% of the balance of your business’ operating account. Surely, if you are like most business owners, you run from one bank account (I had two and though I was savvy). In the full implementation of Profit First, your business will have five bank accounts. Today, we’re starting with just a second account, for profit.

The point to this is that 1% is such a small amount, such a low bar, that you will not notice it gone. Now that you’ve started your profit account, don’t touch it! This is your money and transferring it back to your business is stealing from yourself. You wouldn’t transfer back from your tax account, because that is stealing from the government, so why would you steal from yourself?

Time Block

You’ve heard me preach time blocking before. Your new time blocks will be twice per month to settle your books and pay yourself a profit. Ideally, for simplicity’s sake, these will be the same dates each month, so you’ll know how far back to go. The 10th and the 25th are Mike’s suggested dates. Block these in your calendar on permanent repeat, reminding you to settle your profit account, and then honor that time block. As your profit account grows, this activity will become more exciting!

Grow your profit margin!

In the beginning, you’ll just transfer 1% of your revenues to your profit account. When I say revenue, I do not mean your account balance. That was just a starting point to prime your account. As you move into your new routine, you will take 1% of the total revenues received between your last time block and the current one and transfer it to your profit account.

Rome wasn’t built in a day and a high profit margin can’t be forced in the first month. Industries vary, however, in many serviced based industries, a 40-50% profit margin is considered the gold standard and in manufacturing, 25-35% is considered good. You’ll find your ideal profit margin and I’ll help you set a goal and achieve it, however, you’ll get there through incremental growth. If you transferred 40% of your revenue today, it’s highly likely you’d bankrupt your business.

As time goes, your target should be to increase your profit margin month-over-month. If you did 1% this month, do 2% next month. If you start feeling a pinch from your new profit draws, you have one of two options: raise revenue or cut expenses. Visit your P&L (profit and loss) statement and identify which needs to be addressed. Once you’ve streamlined your business, you can continue to grow your profit margins.

Benchmark and grow!

Profit First uses an Instant Assessment to measure where you are in your business and to set goals for which accounts must grow and which must be reigned in. Take this assessment regularly (at least quarterly) to know where you stand. I’ll post a link to download this tool at the bottom of the post.

This is just an introduction and I hope it has you salivating for more. Profit First is a full business accounting ecosystem to ensure your priorities lie in paying yourself first and increasing your pay as time goes on. If this has piqued your interest, I encourage you to pick up a copy of Profit First, by Mike Michalowicz.

If you need help implementing Profit First or in creating an understandable P&L statement, please reach out. Keep your business lean and your profits fat!