If you’ve been following the blog for any length of time you will know by now that I’m a huge fan of Mike Michalowicz’s Profit First approach to business finance. If you haven’t already read the book, I highly recommend it (you can get a copy here). I also highly recommend implementing the Profit First method in your business as early in its development as possible – ideally, right from the start, but if you have an established business it’s never too late to start!

Here’s the thing: there aren’t many books out there on accounting and finance. The ones that do exist generally fall into two camps: the highly specific ones designed for accountants and finance experts like myself (or those training as professionals), and the basic introductions/guides designed for people who have no professional experience in finance but need to make financial decisions.

Some are designed for managing personal finance, but a lot are geared towards business.

And the majority of finance books are sadly, unbelievably disappointing.

I say this not only from my own perspective as a professional, but from experience speaking to numerous clients, business owners, and entrepreneurs who come to me frustrated by their inability to get a handle on their finances.

They’ve read the books, but they’re not helping.

Why?

The majority of people seem to have some variation of the same core complaint: these books don’t provide an actionable plan that will produce tangible, immediate results.

In other words, even if these guides succeed in explaining finance concepts and methods in an accessible way, the information doesn’t give them a practical way of increasing their profits.

Enter Profit First, the accessible, practical, actionable blueprint for creating and steadily increasing your profits.

A Beginner’s Guide To Profit First

Essentially, Profit First is a book about cash management, but in reality, it’s so much more than that. The perfect accounting hack for busy entrepreneurs who are time-poor and overwhelmed, this system is rooted in human nature and psychology, easy to understand, and perfect for business owners.

Sound too good to be true? Trust me, it’s real!

Here’s everything you need to know about Profit First to become a hugely successful entrepreneur and build a strong, profitable business…

The Profit First Principle

The core principle behind Profit First is flipping the traditional view of accounting and cash flow on its head by changing the equation used to calculate profits and literally placing profit first, ahead of expenses. The traditional method of calculating profit, as we all know it, looks like this:

Notice how Profit is last in this equation. Mike Michalowicz’s innovative Profit First approach is to shift this equation, encouraging entrepreneurs to prioritise the level of profit they want to achieve and find a way to manage the level of expenses they have left to work with.

More importantly, it is changing your mindset around profit and this very important equation:

Parkinson’s Law

When profit comes at the end of the equation we are making do with what’s left over. There’s a little theory called Parkinson’s Law which tells us that work always expands to fill however much time we have available to complete it.

If there are six months available to complete a project, we will spend 6 months working on it. Give us only 1 month, however, and we’ll get exactly the same amount of work done in a sixth of the time.

Often, taking less time over something actually improves the results, because we are more focused and motivated. More than that we surprise ourselves when given a finite amount of time to do things because we defy our expectations of failure and still get them done.

We achieve the seemingly impossible.

Profits and expenses work under the same principle. When profit is at the end of the equation all the money we have coming in is up for grabs. The ‘time’ factor in Parkinson’s law is replaced by the money factor – if we have X amount of money available to us our expenses will increase, gobbling up all that money.

If we have less money available to spend, we will find a way to do the same thing for less.

The problem with viewing profit last is that your expenses are free to expand into that space.

Flip it around, and the amount of money available for expenses is suddenly reduced. It’s finite. The amount we want to earn in profit simply isn’t available and we get the job done with what’s left over.

And it’s not a magic trick. It’s not going to come at the expense of the quality of our services or the products we produce. Rather, it forces us to stick to what is actually available – this much money, no more. We hustle a little harder, think a little deeper, and come up with innovative and creative new ways to do things or create new methods that don’t require as much capital to be spent on expenses.

We surprise ourselves.

We do that which we perceived to be impossible.

The Link Between Profit And Psychology

There are huge psychological benefits to this simple reframing technique, and it’s easy to see why – especially if you’re not a finance professional.

I’m the first to admit that accountants and bookkeepers are…different in their thinking to the majority of other people (save perhaps some scientists) because they think in numbers.

Numbers come naturally to us, and that simply isn’t the case for most people.

There’s a theory that says everyone either thinks in words or images. Neither is better or worse than the other; it’s simply a different way of forming thoughts. Those who think in images are better at visualising things and doing tasks that require pictures, like reading sheet music, while the word-thinkers sometimes struggle with this but are better at other things. A lot of people have a mixture of words and images, and just a few think in totally abstract concepts.

Equations and calculations of any kind can be really tough for people to grasp because it requires them to literally change the way they think.

This is why so many entrepreneurs who are incredibly capable, creative, intelligent and hands-on in their business really struggle with their accounts: they think in words, or pictures, but not in numbers.

Having profit at the end of the equation is, for most people, a clear indication that it is the end result of your efforts. It’s a visual cue and a matter of word order, making it difficult for non-number-thinking people (who are, by the way, in the majority!) to make it a priority because it comes last.

It’s what’s left over after you’ve done everything else.

We naturally focus on things that come first, and when profit is at the end of the equation we seek to increase it by increasing the front. So for a lot of people, the only conceivable way to increase your profits is to increase your revenue.

Reducing expenditure is something that simply doesn’t occur to many people. And if it does, it’s swiftly followed by thoughts of:

‘I can’t, all these expenses are absolutely essential.’

Or, ‘But I have plenty to cover all these expenses, with money left over – I don’t need to reduce them!’

Both of these are understandable perspectives, but they make it very difficult to increase your profits and, most crucially, ensure your business is profitable right from the start.

This is where Profit First comes in because the simple reframing used to place profits before expenses means that expenses are the end result.

The thing that’s left over after everything else is done.

It’s so simple, but it’s an incredibly powerful shift in mindset.

How To Use The Profit First System

Now we’ve covered exactly why using Profit First is such a good idea, let’s get down to the system itself, and how you can put it into practice in your business.

The concept is actually very simple, though at first glance it can seem complicated.

Rather than taking the bottom line as profit – the leftovers – you take a small percentage of the top line. Whenever money comes in, the percentage you have calculated is immediately taken away and reallocated so it can’t be spent on expenses.

Some of it you give to yourself, as wages or dividends, and the rest goes into an untouchable savings account – a ‘rainy day’ fund.

Profit First is as simple as setting up a few bank transfers, but there’s quite a bit of thought that goes into exactly how much those amounts will be for, and how you will effectively manage your business now that expenses have to come out of the bottom line.

Even if you’re comfortable with numbers implementing this system presents some challenges. The most important thing to remember as you work through these steps is that Profit First is more of a mindset shift and change in habits than it is a technical accounting system. The greatest challenge you’re going to face is not with the numbers, but with yourself and getting used to changing life-long habits. But if you have a true desire for change it’s entirely achievable. To help you out I’ve put together a step-by-step guide…

Step 1: Rethink What You Really Need

Here’s the thing about expenses – they all seem perfectly reasonable. There are also obvious ways of saving money, like downsizing from an expensive office space to a more affordable one. And when we do things like this to reduce our expenses, what expenses remain seem even more reasonable.

The thing is, this is based on your perceptions of what constitutes ‘reasonable’, rather than what your business is telling you is genuinely a reasonable amount to spend. Now, I know what you’re thinking, “Erm, Laura, businesses don’t talk!”

But they do.

They really do.

Your profits are literally screaming at you, loads of really valuable insights into your business, and you’re simply ignoring them.

When you don’t have a reasonable level of profitability in your business, that is your business shrieking, “You’re spending too much money!”

It doesn’t matter how much you’re spending, if your profits aren’t where you want them to be, your expenses are not ‘reasonable’ they’re too high, and you need to find a way to reduce them.

So before you do anything else, rethink what you really, genuinely need to spend money on.

Step 2: Put Your Profit First

When you’re allocating money before you even get to your expenses and how much you’ll spend on what, allocate your profit margin first. When you’ve done that, allocate your taxes.

The part most people find difficult is figuring out how much profit they actually want!

This is a question addressed by Mike in the Profit First book, who says the following:

“Of all these businesses in all different fields, I discovered that a healthy million-dollar business will be taking a profit of about 15%. Now, that’s above and beyond the owners being paid $200,000. Then, $150,000 is reserved for corporate tax responsibilities and personal tax responsibilities of the owner.”

If we follow this model you should be allocating around 15% of your revenue to profits, 35% to tax, and the remaining 50% is what is left for your operating budget, including payroll, overheads and any other expenses.

And you don’t need to have a million-dollar business for these numbers to apply. You can apply the same model to any business, of any size, and the principle remains the same. Based on these numbers, Mike developed the Profit First Instant Assessment, which you can take now for free to help you calculate how much your profit margin should be, and how much you have for expenses.

Run through the assessment and use it to calculate your Target Allocation Percentages (TAP).

Step 3: Take Baby Steps

Let’s say for the sake of argument that your profit margin is 15%. If you jump right in an immediately start setting aside 15% of your revenue using this method, you’re going to short-circuit your brain and it’s not going to work.

As I said at the start, this really is a mindset shift, and you are going to want to ease into it.

Jump right up to the full level of profit you’re aiming for, and you’re going to find it next to impossible to cut down your expenses quickly enough to meet it. You run the risk of ‘borrowing’ money from your profits to cover the shortfall, which seems perfectly reasonable, but it’s actually stealing from yourself.

It completely defeats the purpose of the whole system.

So give yourself time to reduce your expenses, allowing you to take – and keep – the amount you set aside in Profit. If this means starting at 1% rather than 15% so be it.

Get in the habit of setting aside that 1% and leaving it alone, without borrowing from it for expenses. Get in the habit of managing with a little less, and spending a little less.

Once you’re used to it, bump it up to 2% and again, take time to get used to the habit.

Keep increasing it in increments and you’ll find it a lot easier to adapt to the change.

Baby steps win the race!

Step 4: Be Brilliant At One Thing

I few weeks ago I was blogging about the power of niche marketing, and the week after that I was discussing the problems with upper limits and the importance of your ‘zone of genius’. Both of these concepts are key to really mastering the Profit First mentality, so if you haven’t already had a read of those take a quick look and come back.

If there’s one area that’s going to trip you up in this plan it is the ‘upsell’ mentality. It goes hand-in-hand with the growth mentality and the notion that entrepreneurs should be constantly pushing for growth. The theory is simple: sell your clients something, then upsell them on something BIGGER.

Keep on upselling so that you’re constantly pushing bigger, better, and more expensive things.

There is some logic in this, at least from the perspective of increasing your revenue. Repeat business is the key to creating a high client lifetime value in your business, after all, but there’s a huge difference between a client who buys from you repeatedly and a client you are constantly upselling on something new.

Upsells have their place but don’t get carried away.

Constantly upselling can actually kill your profit.

When you’re always offering new things it requires you to create new content, buy new tools and materials, learn new things. But more than that it takes you outside your core skill set – your zone of genius – and leaves you doing tasks that you might be capable of, but you’re not particularly spectacular at. 

And that’s okay – nobody’s good at everything!

On the surface, it appears that upsells are great for your profit because they increase your top line. But because of the practicalities and limitations that come with all these new things, you’re unlikely to make any extra profit, and may even eat into the profit you would have had if you’d stuck to the first thing and nothing else.

This is where your zone of genius comes in. Instead of diversifying, get spectacularly good at one very specific thing.

That’s your niche.

Stay in it.

Your niche, your zone of genius, is where you can create the most profit.

Step 5: Create Your Profit First Bank Accounts

Once you’ve got all that sorted out it’s time to set up the (slightly) technical bit. Create some extra bank accounts to act as small ‘buckets’ for different functions. This is a lot easier if your bank has great online services so you can simply do it via online banking. If not, just pop into your local brand and speak to someone who can help you open any additional accounts needed (this shouldn’t cost you any money!).

There are certain accounts with specific functions that you will want to set up, though you may find you want to use additional ones as well:

• Profit – Savings Account
• Tax – Savings Account
• Owner’s Pay – Savings Account
• Revenue – Transaction Account
• Operating – Transaction Account

Make sure that all your incoming money from invoices and any other sales and sources are deposited in your Revenue Account.

It’s a very good idea to have a reliable and efficient accounting tool that will help you to automate everything and keep on top of things. If you don’t have one or don’t like the thought of trying to manage your accounts yourself, investing in a great bookkeeper to help you is a fabulous alternative. It may be a one-time job to get you set up, or you can hire someone on an ongoing basis.

Step 6: Transfer Your Money

Exactly how you do this part will vary slightly. If there are certain payments you have coming in on a regular basis from subscriptions, standing orders, direct debits, or other regular payment methods, you can set up bank transfers that automatically transfer the correct percentage of your deposited funds into the right account.

If your income isn’t that regular, or you have some income that is irregular, you can manually calculate and transfer the amounts. It’s a good idea to do this every two weeks, by calculating the amount of deposited funds since the last time your allocated your percentages, and transferring the relevant amount to the right account.

The most important thing at this point is to discipline yourself so that you don’t take money from the wrong account. This is absolutely crucial. Take another look at the accounts we set up in the last step:

1. Your profit account is where you will accumulate profit – don’t touch this money, leave it exactly where it is.
2. Your tax account contains money set aside for GST and tax purposes. Again, don’t touch this (unless it’s to pay your GST or tax bill!).
3. Your owner’s pay account is money used to pay your own wages or drawings (this you can touch, but only for personal use, not to cover business expenses!). You can use an existing personal account for this.
4. Your operating account should be used to pay your day-to-day expenses and running costs.
5. Your revenue account is where all your incoming money is deposited. No spending from this account!

Getting the Profit First system setup can take a little time and patience, and don’t be surprised if it takes you a while to get used to it.

Starting any new habit is tough, and money habits are particularly tricky. Persevere, it’s well worth it!

Get Started Now with the Profit First 101 Course.

If you’re totally sold on this idea and want to implement it in your business but you’re still not sure where to start, or simply don’t have the time to figure it all out, we can help.