There is no such thing as a silver bullet in business. Overnight success isn’t real. Businesses that truly succeed are the result of incredibly hard work. Successful businesses not only have a great product or service that people love, they’re also able to generate profit that allows them to continue to deliver with the highest quality while fairly compensating their team and themself. Implementing the Profit First Method allows this type of success to be a reality for you and your business. The Profit First Method is a book written by Michael Michalowicz. In his book, Michalwowicz demonstrates a novel way of operating your business.
What is the “Profit First” Method?
The traditional way of thinking about profit is:
Sales – Expenses = Profit
The Profit First Method doesn’t leave profit for last (hence the name), rather calls for taking a profit separately from dealing with expenses:
Sales – Profit = Expenses
The Profit First Method reimagines cash flow management by changing your approach to profit. We usually think of profit as the output of our business. In the Profit First Method, profit is an input: It’s what we have in the bank. Our expenses become the output.
Your business is on a budget. The Profit First Method calls for a business to follow your budget and also be sure that as an owner you’re taking a profit before you spend on expenses.
The result is twofold:
An accurate understanding of where you’re spending your money and how you’re spending money.More money in your pocket.
How does the “Profit First” Method work?
Putting the Profit First Method into practice will require a mindset shift. The profit first method is where you are taking profit out of cash before your expenses, as opposed to paying yourself with the leftovers from expenses. You’ll need to create a system where you transfer predetermined percentages of your cash deposits into smaller separate account buckets such as: profits, taxes, operating costs, owner’s payments and revenue.
The amount you put into each account is calculated by your Target Allocation Percentages (TAPS). Your Current Allocation Percentages (CAPS) is how you’re spending your Real Revenue now. These are known as the “Profit First percentages”.
Profit First Percentages Explained
The great thing about the Profit First percentages is that they’re a window into your businesses financials. Current Allocation Percentages (CAPS) give you a clear picture of how you’re allocating your finances amongst income, owners compensation, operating expenses, profit and taxes. This is your Real Revenue now. Target Allocation Percentages (TAPS) are where you want to split your financials to increase profitability, cash flow and overall business growth. This is where your Real Revenue will go when you’re operating profitably.
When you put the Profit First allocation percentages to work, your aim is to (slowly) move from CAPS to TAPS.
Mike Michalowicz created this Proft First chart to help determine what your businesses target allocations should be based on your real revenue range.
Image: TAPS Chart by Mike Michalowicz from paultlong.com
What are the Profit First Accounts?
There are five Profit First accounts. They are:
Income: an account containing your earningswhere all of your cash goes.Operating Expenses: an account for all of your business expenses like hardware, office supplies, travel and marketing. This is where you can take a hard look at your business and determine if these expenses are necessary or not.Profit: an account to use for debt reduction, emergencies and your bonus. This is where the Profit First method shines because the Profit First formula exists to generate profit!Tax: an account for the taxes you’re responsible for paying.Owners Compensation: an account for your after-tax salary. Yes! You need to pay yourself.
In order to track your TAPs, you’ll need these five accounts. Once you have these Profit First accounts, you’ll distribute the funds amongst them. Banking with Lili is a solid banking solution when implementing the Profit First accounts. Lili has no fees, hidden or otherwise, when it comes to managing the accounts recommended in the Profit First Method. We’ll address that in the final section.
Use the Profit First Formula and Open Profit First Accounts with Lili
To start putting the Profit First formula into action, you’ll first place all of your income into the income account. After that, you’ll want to establish a cadence that works with your schedule to distribute the necessary funds into the Owners Compensation, Operating Expenses, Profit and Tax accounts. The book suggests the 10th and the 25th days of each month and you should choose a schedule that works for you and your business.
You’ll use your Profit First accounts to pay your bills. Remember to be sure that each account is used for its designated purpose as outlined above.
Implementing the Profit First method and Profit First formula can be intimidating and overwhelming. It’s important to choose a bank that has capabilities that align with this method.
Specifically designed to support your business and the Profit First accounts required to implement the Profit First formula, Lili’s business checking account is where your Income and Operating Expenses will be housed. The profit account will be funneled into Lili’s emergency savings bucket and your Tax account will go into the tax bucket. Finally, and most importantly, Lili enables you to seamlessly deposit your Owners Compensation into a separate account dedicated to owner’s pay.