Running a business, big or small, can be challenging. Start-ups are even more difficult, since your brand probably does not have a following yet, and it can be challenging for sales to meet target numbers.
If your business is having a hard time, perhaps it might be time to take a new approach. Business finance expert Mike Michalowicz recently published a book that introduces the Profit First concept. This concept is gaining popularity across multiple businesses due to its basic yet effective technique in running a business.
To help you find out if the Profit First concept is the answer to your business woes, here are a few things we know about it.
What Profit First Means
The generally accepted formula for profit that we learned in school is that Income – Expenses = Profit. While this formula works, it treats profit as the end result of a process. With this mentality, you are okay with treating whatever remains after paying expenses as your profit for the period.
The Profit First formula is slightly different, exchanging the Expenses and the Profit places, to come up with Income – Profit = Expenses. In this mindset, your business prioritizes getting the profits first by assigning a fixed percentage of profit for every sale. After you get your full income, you calculate the profits generated based on your assigned values and set them aside. The leftover money is then used to pay off expenses.
How It Affects the Way Businesses Are Operated
Parkinson’s Law claims that work expands to fill the time available for its completion. In simpler terms, people are generally conditioned to use up as much time and resources as available to them. For example, if you pay a delivery service $500 to transport your document in a week, there’s a pretty good chance your parcel will take precisely one week to arrive, no sooner or later. If your document were as urgent as a subpoena service, it would indeed have been better for you if you received it earlier. The same goes for business operations, as many business owners have the habit of maximizing resources to make sure they are fully taken advantage of. We think it’s okay to spend up to the last nickel in expenses because it’s what we initially allotted for. However, if we only used what was necessary, we could have increased our projected profit instead.
A Profit First mindset modifies this habit to the business’s advantage. By taking the profit off the board right away, the business will have no choice but make do with the remaining budget to cover its expenses. Forcing the business to lessen costs because there are no more funds available can help locate more affordable sources of the same services that the firm regularly pays for.
How to Utilize Profit First in Your Business
You will need to open five separate bank accounts to utilize the concept of Profit First fully. The five accounts will each stand for (1) total income, (2) profits, (3) personal compensation, (4) government taxes, and (5) expenses.\
Once you receive your total business income, you must deposit the full amount into its respective bank account. Then, ideally, twice a month, you will transfer funds from the total income account to the other four ledgers.
You will first transfer to the money to the profit account, following the name for this concept. You will then allocate funds for yourself via your compensation account, then comes the taxes account to make sure you don’t miss a payment. Finally, the remaining money goes to the expenses account to settle your business’s bills.
One of the challenges in this method is keeping the money set in their respective accounts. It’s easy to get tempted and transfer funds from one account to another for various purposes. Once money has been allocated to an account, it shouldn’t be moved anymore unless it’s an emergency or for the business’s best interests.
The Profit First system banks on the business owner’s commitment to stick with the method. By making the necessary allocations without moving the money, you ensure that your business works the way it should while also getting your profits immediately. It allows business owners to enjoy the perks of financial success as long they can adjust expenses accordingly for the budget to work. If the money in the expenses account ends up short of what should be paid, it’s a sign that the business is spending more than it can afford. The business owner needs to be skilled in understanding which expenses should be cut and how more affordable resources can achieve the same effects.