Have you ever had a cash flow crisis? If you’re in business, chances are you’ve faced a major cash flow situation at some time.
When I was just starting out in business, I almost sent my business broke because I spent more money than I made – and I didn’t realise it. I had miscalculated my spending and expenses (and I didn’t put my profit first), which led to a massive cash flow crisis.
Thankfully, I was one of the lucky ones and was able to turn my business around; others aren’t so fortunate.
It’s one of the very common mistakes many business owners make.
Years later I learned the Profit First method to build a sustainable business and create long-term success.
It’s what I needed when I first started.
What is the Profit First Method?
The brainchild of author Mike Michalowicz, the Profit First system (outlined in his book of the same name), does what it says and helps transform your business by putting your profit first … where it belongs.
The idea of Profit First is to help businesses become profitable and stay profitable from their first sale.
How does it work?
Think of it as the new-age, electronic “money in the envelope” process. It works by divvying up your money into different accounts to prioritise the important areas of your business, the top one being profit.
What are the Profit First Method accounts?
- Owner’s pay
- Expenses/operating costs
The reason the approach is successful is that you physically move your money into the respective accounts and what’s left is what you have to spend.
So you always know what you have to spend and you are prioritising your profit and your own pay first.
When do you transfer? It’s about creating a habit and then doing it regularly. It might be weekly, fortnightly, or monthly. However, the Profit First system calls for it to be done on the 10th and the 25th of the month.
How to implement the Profit First method
The process is different and it depends on if you are an established business or a new business.
AS A NEW BUSINESS: There is no historical data to review as a new business, so you would start with your estimated income and expense forecasts, and work out a profit implementation plan from there. A qualified bookkeeper, accountant, or Profit First professional can help with this.
ESTABLISHED BUSINESS: Use your historical data to create and implement a profit plan. Look at your profit and loss and balance sheets.
The recommended profit percentage guide for small businesses up to $250,000 is:
- 5% Profit
- 50% Owner’s pay
- 15% Tax
- 30% Expenses
The way you divide your percentages will be dependent on your reality. You will, however, eventually work your way up to this recommended percentage profit.
PAYING TAX: This “envelope” is extremely important because we all need to pay tax. However, calculating tax may be difficult. It’s best to work out your tax based on the recommended profit percent, which is 15% (for businesses up to $250,000). Professionals can help you work out your tax and what to put aside. It is 15% because we generally pay tax on income less expenses.
What about GST? You can set up a separate GST account if you are registered. However, you can use your tax account for your GST. The distribution amount is worked out on your income less your GST.
OPERATING EXPENSES: Review your expenses, bills and insurances, loans, and work out the amount you need to put aside for each. One of the best tips to keep your operating expenses down is to shop around for the best price and products for your business. Do this on an annual basis.
What is the difference between profit and owner’s pay accounts?
Your owner’s pay amount funds your living and personal expenses and spending money.
The profit account is built up over one quarter and at the end of the quarter, you can take a profit distribution to reward yourself for being successful in business.
Professionals recommend taking only a 50% distribution of the profits each quarter and leaving the rest in the profit account to grow and fund your business if you are sick or injured and are not generating income at any time.
To put profit first, you need a profit-first mindset
Repeat this mantra: You deserve your profits!
It’s important that you take a distribution because it's a reward for being successful in business. However, taking profit from your business may require a mindset shift. It can be challenging to give yourself a reward when you want to keep as much money in the business as possible.
But the concept is that is a reward because you have been successful.
How to feel confident about taking your profit:
- Having a plan for your money will help you feel more confident about profit.
- Speak to a professional to help you get set up and give you confidence in your choice.
- Provide a profit distribution for a purpose, such as a holiday, mortgage, paying off personal debt, or buying yourself something that you’ve always wanted, or even just to go to the movies or have a massage.
Getting into a rhythm of paying yourself your profit distribution is exciting once you are comfortable. It might take 2-3 quarters for you to feel comfortable, however, when you see the results and how you will benefit will keep you going.
The Profit First Method: What to do next?
If you haven’t read the book, Profit First, by Mike Michalowicz – start with it. Then open a profit account and start putting 1% into that account regularly.
You can purchase the Profit First book by using our affiliate link here https://onlinebusinessliftoff.com/Profit_First.
If you would like to know more about where to start with your finances as a new business owner, creating good money habits, prioritising your profit, and using the Profit First formula, tune into our podcast with Bookkeeper Tracey Sellers, from Ironbark Industries Bookkeeping, where she shares her insights.