Do you have have a pile of profit set aside, steadily growing as your business generates wealth?
There’s no shame in admitting that you don’t, because most entrepreneurs don’t have that (yet).
Profit is colloquially defined as “the money I hope I have left over at the end of the year.”
But there’s a better way to run your business, and yes it is possible to pile up profits after every single sale, month after month.
For every sale you make, separate revenue into dedicated bank accounts for profit, owner’s pay, operations, and taxes to make sure you spend no more than you earn, you always pay yourself, and you stay out of debt. That’s the Profit First system.
You probably calculate this way: Sales − Expenses = Profit.
Your accountant probably uses Gross Income − Gross Expenses = Net Income, and both equations are technically correct—but practically useless.
That’s because these paths to profit are rear-facing metrics. By the time you’ve calculated your profit, all you have are the leftovers, and the rest is already spent.
This last insight was inspired by Mike Michalowicz in his book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine. As the title implies, rather than thinking of profit as the money that’s leftover, why not calculate profit first?
Mike’s system, Profit First, is articulated in his blog and bestselling book, but also by a fleet of certified Profit First Professionals who practice Profit First accounting with countless business clients across the globe.
Profit First has helped many entrepreneurs rethink their business relationship with money, and simultaneously left some accountants shaking their heads that the system is “unnecessary” as they point to a stack of financial reports.
It’s true, you can get all the financial information you need to make calculated business decisions from reading your cash flow and profit & loss statements in your accounting software—but will you? And will your bookkeeping always be caught up to the current day?
Most financial systems simply track and project where you have already earned and spent money. The more advanced systems include where you think you will earn and spend in the near future.
Instead, Profit First creates hard boundaries to control your finances.
It starts with flipping the traditional accounting formula on its head so that expenses are based on what’s leftover and profit always comes first: Sales − Profit = Expenses.
Wait a minute… with a bit of Algebra 101 you might be thinking that the first equation and this new equation are equal, and you’re right! Each profit formula is equal, mathematically, but incredibly different in how they affect your business, day to day.
With Profit First, you immediately set aside profit from every sale and only spend business expenses based on the remaining funds, so your expenses are your leftovers and you always get paid.
Practically speaking, that means that as money flows into your business, you split sales income into dedicated bank accounts for different purposes.
For my business, I have one income account where all revenue comes in, and then I split that into four other accounts twice a month:
- Profit (5% of sales)
- Owner’s Pay (50% of sales)
- Operations (30% of sales)
- Tax Reserve (15% of sales)
When you implement a similar system in your business, you have a complete at-a-glance view of where your money is and where you can spend it (along with where you cannot).
You need your financial system to help you drive your business the way you drive your car: 90% of your visibility is forward so you can see where you’re going through a large, clear windshield.
Looking back, all you need is a small rearview mirror to stay on track.
Profit First is more than just a bunch of bank accounts; it’s a system with a built-in philosophy of financial business decisions that mean you spend no more than you earn, you always pay yourself, and you stay out of debt.
I have an entire chapter of Survive and Thrive dedicated to this system, but if you want to give it a try the best resource is Mike’s book, Profit First. Mike has also been the featured guest on two episodes of the Thrive School podcast.