I came across the book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine by Mike Michalowicz when I decided I was going to venture into the world of affiliate marketing. I had two semesters of accounting when I was in college and felt like I had a good grip on basic Generally Accepted Accounting Practices (GAAP) but this book spoke to me when I saw it turned those principles on their ear and showed their problems.
So, I implemented it into my new business from the start. Here is my review of Profit First, and a bit of a spoiler, it is a positive one.
The Premise of Profit First Accounting
Income – Expenses = Profit is the GAAP (Generally Accepted Accounting Principles) method for calculating a company’s profit. It’s rational and straightforward. Unfortunately, it’s a fabrication. While the formula is logically correct, it does not account for the way people actually behave. Profit is a leftover in the GAAP formula, the last consideration, something that will hopefully come as a pleasant surprise at the end of the calendar year. Regrettably, profit is rarely present, and the business continues to rely on payment to payment survival plans.
Income – Expenses = Profit is now Income – Profit = Expenses
With Profit First, you flip the formula to Income – Profit = Expenses. The math is the same from a logical position, but the entrepreneur’s behavior is vastly different. Profit First allows you to take a predetermined percentage of profit from each sale first, leaving only the rest for expenses.
Application of Profit First Book
The idea is that you take whatever comes into the business and you remove your preset profit percentage out first before you pay any bills or other expenses. (Mike provided a chart for recommended percentages by income levels in the book) This book is designed for small business owners in sole proprietorships, partnerships, or LLCs.
The application of Profit First causes some amazing things to happen. First, the business is immediately profitable for the owner who has put so much at risk to build that business. (It is the goal of every business to turn a profit after all, not run a charity.) Mike points out that often the owner is the best “employee” of the business- they are the best salesman or creator, etc. in the business and deserve to be paid an owner’s draw worth at least close to what they would have to pay someone else to do the job.
Often the owner looks at their business account to decide if they can afford something without thinking about the profits, they have not paid themselves yet. This in essence means the owner is using personal money to buy the company’s assets.
The second is that it gives a quick accurate test of your business health. If you take a reasonable profit out and there is not enough for the expenses, your company can’t handle that level of expense. You must immediately start to cut the nonessential expenses you over-extended yourself on.
Profit First and Parkinson’s Law
Have you ever heard of Parkinson’s Law? Author and historian, C. Northcote Parkinson, proposed that our demand for a resource rises in response to its supply. That is why if we are given two weeks to complete a project, we complete it in two weeks, and if we are given eight weeks to complete the same assignment, we complete it in eight weeks.
That is why if we are given a $1,000 budget to accomplish a task, we find a way to complete it for the $1,000, but if we are given a $10,000 budget to perform the same task, it takes $10,000 to accomplish. Parkinson’s Law is turned into an asset by Profit First. By prioritizing profit, the amount of money available for expenses decreases, forcing us to find ways to accomplish the same tasks for less money.
The same is true of plates of food, we don’t like gaps or empty spots so we seem to fill our plates up. I have even heard Mike tell the joke “George Washington’s mom told him to clean his supper plate too, but his plate was the size of our dessert plates.” He even tells a funny story about his son and his cereal intake per day and how Mike used this law to control his son’s intake.
And when it comes to the business bank account, the owner does the same thing… “Can I afford this?” *Looks at the business account without contemplating profits*, “there’s enough money” and it is spent on the new expense. This law dictates that expenses expand to fill the amount “available”.
As I said above: ” Parkinson’s Law is turned into an asset by Profit First. By prioritizing profit, the amount of money available for expenses decreases, forcing us to find ways to accomplish the same tasks for less money.”
Profit First and Thanksgiving
One of the things that really resonated with me was his concept of teaching that Income should be looked at like a serving tray at Thanksgiving. When that roasted turkey has been bronzed to perfection, it is placed on a serving tray to put on the table. But no one eats from the serving tray, they all have their own plates that their portion is placed on.
The way the Profit First System works is that you set up accounts designated for separate needs. The income account is the serving tray and other accounts are set up to mean their purpose: EX- 1. Profit account, 2. Taxes Account 3. Payroll Account, 4. Expenses Account, etc. to fit you.
Just like the owner in GAAP has profit as aforethought, the same is true with taxes. The best thing you could do is pay your taxes when you are paid, and not as aforethought scrambling at quarter taxes time to figure out where the money is going to come from.
The same is true with Profit First. The income is the serving tray. Your personal checking account is the profit account and you set up accounts as needed to divide the other, starting with the tax account. Then moving on to expense account(s).
Let’s say that you made $1000 income (let’s keep it simple for my math skills) then you would put your profit amount (let’s say 20%) into your checking, so $200. Then you move $150 (15%) to your tax account to hold until quarter taxes are due. The other $650 would be sliced into how many other places you decide to divide them (expenses, payroll, etc.)
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Profit First and Parkinson’s and Thanksgiving Combined
So, using the example above and our understanding of Parkinson’s, we see that our company needs to be able to operate on $650 instead of the whole $1000.
Parkinson’s Law leads to you having to figure how to run the business on the $650 by “cutting the fat”. This means seeing if there are expenses that need to be cut or services that don’t have enough ROI to continue offering and taking away time on the services or products that have better ROI. Streamlining your company is always a great thing to make it operate better.
Thanksgiving concept allows the owner(s) to be profitable from the start, have the company pay their taxes without worry when due, and have a company that is well organized to be healthy and productive. It also pushes owners to always be looking for a better way to do things.
The combination of the two is the power behind this strategy. As you slice up the income into their accounts in preset percentages. You see how much you can spend on each by the numbers you have. Good healthy checkup or quick answer to if you can expand on an area.
Let’s say the company makes $100,000 each month. The owner has preset percentages of 20% profit, 15% taxes, 25% payroll, 10% rent/utilities, 10% equipment and 20% supplies. While it is not required to have so many slices, the more categories you have the more Parkinson’s Law will help you.
They can easily see where the money will go to see what they can afford. Need more help? Need new equipment? Check that account to see if it will bear more expenses without surpassing your limits.
Addition Can be Subtraction in Disguise
As an offshoot of over-extended on expenses and another lesson in the book is businesses can be over-extended on offerings. It can force you to look at the return on investment (ROI) of your offerings because not all income is equal. He details a story of his lawn service guy to prove this point.
One day the man who owed the lawn service that Mike used offered Mike the opportunity to have his gutters cleaned as a newly added service above the lawn care. But Mike explains that adding this service cost the guy initially more to buy the ladder, gutter snake, etc. than what the service cost AND how many fewer yards he could do while he is adding this service. Addition can sometimes be subtraction in disguise.
Let’s say he charges $100 for the lawn care and $35 extra for the gutters, but for every two houses that add the gutter service, it is one less yard he can do that day. He not only added the extra expenses of the gutter tools needed (and possibly time to go buy them), but he just traded a $100 yard for $70 on every two new gutters. That is the definition of subtraction by addition.
Profit First Bank Accounts
Profit First teaches you to have different accounts for each division the “turkey” is sliced up into. Some of these he suggests are checking accounts to be able to easily pay your designated expenses. Others he suggests are saving accounts to try to earn a little interest on as they are not used as much- a quarter tax account is an example.
One of the concepts is that the accounts (especially income account) need to be no minimum balance and no monthly fees to make the system work. The income account is sliced up twice a month (the book explains when and why) so that twice a month at least that account is zeroed out.
He also suggests in the book that some of the accounts need to be hard to get to, maybe don’t have online access or in a town over, so that you are not tempted to “borrow” from those accounts to cover another account’s responsibility. That is what “trimming the fat” is for.
The number of accounts is really up to your needs and how much you want Parkinson’s Law to assist you, but you really need at minimum 3 business accounts not counting personal profits account for this to work.
My Final Thoughts
I love the premise of this book and the small business lessons it teaches beyond the accounting style. Mike teaches it in a way that is not only easy to understand but with a lot of humor and self-deprecation that inspired his revelation of Profit First.
I have the book in both written and audio and highly suggest the audio as his explaining is easier to understand with his humorous added commentaries.
He also understands that this being different, it might be hard to get to the percentages he suggests and teaches you about Current Amount Percentages (CAP) and Target Amount Percentages (TAP) and shows you how to get from your CAP to your TAP at your pace.
My only problem with the setup taught is I am a pretty disciplined guy so I don’t feel the need for all the accounts that he suggests with the more advanced version, but I can see how for others it might benefit the efficiency process more. It does teach a basic setup and a more advanced one for those that need or want it.
I highly recommend you buy the book and try to implement it in your business, whether you are just starting or have been operating for years.
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