Is Profit First right for your business?

Have you been wondering if Profit First it is the right choice your business?

In this blog I set out what it is, how it works, the downsides to watch out for and what stage of business it best suits.

What is Profit First?

It is a method of managing your business finances, outlined by Mike Michalowicz’ in his book, Profit First. The main concept is that business owners take a percentage from each sale as profit. This differs from the traditional profit formula of deducting your expenses from your sales, leaving you with profit.

By flipping the traditional formula, Profit First seeks to reframe ideas around cash flow and budgeting and encourage business owners to pay themselves a fair amount.

How does Profit First work?

The business owner transfers different percentages of their sales from the income bank account into four separate bank accounts, at set times during the month.

The percentages are usually predetermined for owner payments, profit, taxes and expenses. For larger expenses the method suggests creating additional bank accounts.

If you have worked out your percentages well and are diligent and disciplined with your money, then the method can work well for you. 
 
While I agree that business owners should have a separate bank account for their taxes and super, I don’t agree that you need separate accounts for income and for expenses as this can become time consuming managing multiple accounts.

So long as you have a budget and a way to track where you are with your cash flow, that is sufficient.

I suggest having less bank accounts so it’s not so time consuming and confusing transferring various percentages, and it’s easier to manage. You could follow this method with only two bank accounts: the first for tax, GST, PAYE and super, the second for income and expenses. In addition, you’ll need to set up a payment to a personal bank account for a regular “wage” to the owner based on your budget.   You do need to have a good bookkeeping system that you keep updated which is best practice anyway.

If you are going to use this method, then step into it gradually. Resist FOMO and overwhelming yourself with multiple accounts.

The Downsides to Profit First

Before diving into this method, it’s important you’re aware of some practicalities:

1.      Not everyone will be able to work out the percentages for each account, especially the percentage of tax to put to one side. This calculation is best discussed with your accountant as everyones circumstances are different. This isn’t a number you want to get wrong.  If you are using bookkeeping software it will calculate some of the figures for you (e.g. GST or PAYG from employee wages). Other figures will need to be calculated manually.

2.      Having multiple bank accounts can result in unexpected costs for account fees and transaction fees from your bank. Before deciding on the number of accounts you’ll be setting up, check on the fees that your bank charges as they all charge in different ways.  Using different types of accounts, such as a savings account over a transactional account, that restrict the number of transactions can also provide a disincentive to withdraw money – which can be a good thing for some of the accounts.

3.      Shuffling money between different accounts can become an administrative nightmare. You need to be very clear at the start what you will be transferring to each account and when, otherwise it can quickly become overwhelming.  To begin with this method seems easy then, as your focus gets shifted to other priorities in your business, it gets left behind.  In the start-up phase it can be especially overwhelming when you find your expenses account is running out of money particularly when you’re under stress with other business and personal demands.

4.      There can be a temptation to “borrow” money that is building up in one account when funds are running low in another account. It’s essential that the percentages you’re transferring are as accurate as possible otherwise you could find yourself running short when a large expense is due.  If you’re the kind of person who has difficulty controlling your spending it can be very tempting, when faced with 3 accounts that have money sitting in them, to spend funds on things you don’t need.

Profit First is not a magic solution, it’s simply one way of managing your money and it’s not going to work for everyone.  You need to be very disciplined and not all of us are.  And it takes time – 2 to 3 years to implement fully.

The ideal stage to fully implement Profit First in your business is when you have stable and growing income. Until then it can be a distraction from the actions you need to be focused on. From day one in your business you have a lot to learn and implementing a method like Profit First will only add to that list and could create overwhelm for those who are focused on finding their first clients.

One of the best things you can do when you start your business is to create a simple way of allocating cashflow using your budget and your bookkeeping program, one that can grow with your business and reduce the initial confusion.  It can also help you transition to the Profit First method faster.

Do you want to improve your money management and you’re wondering if Profit First is for you? Or have you tried Profit First and it’s not working for you? Book in a 20-minute call with me and we can discuss the right method for you. Book your call below.