Profit First

03
Sep
2020
This Simple Habit will help you Build Wealth!

This Simple Habit will help you Build Wealth!

I was recently reading Profit First, by Mike Michalowicz. He is an advocate for taking your profit first (as the title suggests) before you pay any of your business expenses. The goal, long term, is to increase your profit savings and to force your business to run on a leaner budget. This should always be our goal in business, but what about at home? Is it really that much different than a business?

For those of you in business, this will be a quick refresher, however, the generally accepted means of cashflow in a business are:

Revenues (Income) – Expenses = Profit

The trouble with this logic is that we are giving away all control of our profit and leaving it as an outcome of your earning and spending habits. I don’t much trust fate and do not want to put my financial health in its hands.

In Profit First, Michalowicz suggests we look at a model like this (which I have simplified, for the sake of this demonstration):

Revenue – Profit = Budget for Business Expenses

The beauty of this model is that you are paying yourself, which last I checked was the reason most of us got into business, and forcing the business to run on the remainder. I have laid out 11 steps to apply the same principles to your personal finances. Off we go!

Apply Profit First principles to your personal finances

  1. In the book, Michalowicz instructs you to open up multiple bank accounts, to remove temptation and keep your budget fixed. The system is a modern-era, web-enabled version of the old envelope budgeting system, where you have an envelope for each major savings and spending category. People who practice envelope budgeting will get their paycheck, cash it, and divide it into envelopes, based upon their priorities of spending (i.e. emergency fund > rent/mortgage > food > bills/utilities > entertainment).
  2. Analyze and categorize your personal P&L (Profit & Loss). Go back over three months of bank and credit card statements to determine averages.
  3. Group those transactions into big buckets. Your core buckets should be: Income, Savings, Critical Expenses, and Luxury Expenses. As you progress in this model, you may add more buckets, say to save for something special which is further away (i.e. down payment on a vacation home).
  4. Once you’ve determined your percentages of your gross income going into each category (CAP Current Allocation Percentage), set a goal to increase your savings and to decrease your expense strategies (TAP or Target Allocation Percentage). It is possible you have not been saving anything and that your Savings will be 0%. Start small. Set a goal for just 1% this month. It’s so insignificant you won’t even feel it.
  5. Go to your bank and open a checking account for each bucket. Rename your current checking account to be your Luxury Expenses account. We don’t want automatically paid bills and charges coming out of your Income or Savings accounts. The labels should include your CAPs and TAPs and look something like this:

    Income
    Savings (C-5% T-35%)
    Critical Expenses (C-65% T-50%)
    Luxury Expenses (C-30% T-15%)
  6. On day 1, take the current balance in your Luxury Expenses account (the one which was your general checking account) and move it to your income account. Get your calculator out, multiply the total in Income by the CAP of each category, and make a transfer from your Income account to each of the other accounts. When you are done, your Income account should be zeroed out. If you had $1,000 in your Income account, the balances when you were finished would look like this:

    $0 – Income
    $50 – Savings (C-5% T-35%)
    $650 – Critical Expenses (C-65% T-50%)
    $300 – Luxury Expenses (C-30% T-15%)
  7. When your paycheck goes into your Income account, you’ll make disbursements, according to your CAP, listed on the account’s label, as you did on day 1.
  8. Update your payees and creditors to come from the appropriate expense account. This will be a great exercise in finding which expenses you can cut right away. If you have to update the bank or debit card information on that subscription service that sends you boxes of junk each month (you know… the ones piled up in the corner of your office), this may help you identify what to cancel instead.
  9. Do NOT use your Savings to pay for Luxury Expenses! If this were envelope budgeting, that envelope would run dry and your fun would be over until your next pay day.
  10. Make adjustments as you go. Each month, make it a goal to increase your Savings CAP to be 1% closer to your TAP. You can’t have 101% so that 1% will have to come from somewhere. Attack the Critical Expenses first, before you mess with your fun money! I bet you didn’t think I would suggest that. Before you take away from great memories and a fun life, see which unnecessary expenses you can cut or which bill you can renegotiate, to bring your Expense CAP down by 1%.

What you’ll find is that your 1% savings, as small as they may start out, will add up and gain momentum. In the above example, if you have a take home bi-weekly paycheck of $2,300, a 5% CAP would be $115 per paycheck or $2,990 per year… A 35% CAP is over $20,000 in Savings per year. What would that do for your life?

Take action today and commit to doing it by sharing this blog post on Facebook, Instagram, Twitter, LinkedIn, or your social media platform of choice, and declare you are taking action on your finances. If you want extra accountability, be sure to tag me, Adam Lendi, in it. I will add you to my accountability checklist to make sure you are remaining committed to your goals and your financial freedom!

Posted by Adam Lendi in Budget & Finance, Life, Tools, 0 comments
21
Aug
2020
Can you spare 1%? (Hint: it’s for YOU)

Can you spare 1%? (Hint: it’s for YOU)

“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!

Download the Instant Assessment

Posted by Adam Lendi, 2 comments