How does profit first work?
You may or may not have heard about Mike Michalowicz’s book: Profit First.
If you haven’t read it yet, or would like to read it again, you can find the book here. We’ve also done a review on one of our favourite books, The E-myth. Read about it out here.
My mission is to eradicate entrepreneurial poverty. Entrepreneurial poverty means being broke financially, emotionally and physically.
Mike Michalowicz.
We’ll be looking at the following:
- The Book in 3 Sentences
- The Problem
- The Solution
- How To Get Started
- Last Remarks
The Book In 3 Sentences
Before you pay your expenses, take your profit first. Run your business based on what you can afford to do today, not what you hope to be able to afford someday. When profit comes first, it is the focus, it is never forgotten.
The Problem
Business owners pay everyone else and then give themselves whatever is left (if anything). As businesses grow owners don’t necessarily make more money unless this is their focus.
You could own a £100,000 business and take home £50,000. Or a £1,000,000 and take home £50,000. The latter is just more stressful. You need to figure out how to grow your business whilst ensuring it’s increasingly profitable.
The Solution
The profit first cash flow management system. How does profit first work? Take your profit first using the following simple steps:
- Open 5 bank accounts:
- Income
- Profit
- Owners Pay
- Tax
- Operating Expenses
- Allocate your income each week according to your TAPs.
- Watch your money grow.
TAPs
Great, sounds simple enough, but what is a TAP and how do we know what ours are?
TAP stands for Target Allocation Percentage. It’s essentially how we want to allocate our funds.
To get here, you need to know your CAPs (Current Allocation Percentages). You can work this out by looking at where your money currently goes without this system.
E.g. You make £10,000 a month.
£4,000 goes to your operating expenses.
£2,000 goes to tax.
£1,000 you keep in the business. (profit)
£3,000 you take home. (owners pay)
Your CAPs would look like this:
40% Operating Expenses
20% Tax
10% Profit
30% Owners Pay
The table below also gives an indication of what Mike thinks this is reasonable depending on your size. Keep in mind there is no one size fits all solution here, this will depend completely on you and how you run your business.
Tips from our team:
- Think about your level of risk. Do you want to keep 1 month worth of cash in the business for a rainy day, or would you rather have 12 months worth of expenses in the bank?
- Look into the future. What is your ideal owners pay? Do you have any upcoming big investments?
- Keep your operating expenses under control. Look through your expenses at least once a month to ensure you are not paying over the odds for anything.
- You can change these figures. The most important thing is to start.
How To Get Started
- Work out your CAPs using your current financial data. Ask your accountant for your latest profit and loss account to help you get started.
- Determine your TAPs. Use the data in the table above, your CAPs, and industry knowledge to determine this.
- Set your bank accounts up and a simple spreadsheet to help you keep track.
- Start with week 1. Even if that’s just putting 1% away.
- Continue every week. Schedule a time in your diary to move your money around and make sure you’re on track.
Last Remarks…
•Money is the foundation. Without enough money, we cannot take our message, our products, or our services to the world. Without enough money, we are slaves to the businesses we launched.
•Growth is only half the equation. It is an important half, but still only half.
•The perfect size for your business? It will happen naturally, when you take your profit first.
•Profit is not an event. Profit is not something that happens at year-end or at the end of your five-year plan or someday.
•Profit isn’t even something that waits until tomorrow. Profit must happen now and always.
•Profit must be baked into your business. Every day, every transaction, every moment. Profit is not an event. Profit is a habit.
•“Revenue is vanity, profit is sanity, and cash is king”