As a CPA and someone who makes a living teaching financial literacy and cash management to small business owners and self-employed individuals, people routinely ask me my thoughts on Profit First, the book and business cash management system by Mike Michalowicz.
For those who aren’t familiar, the Profit First system centers around using bank balances to manage cash instead of more conventional budgeting and monitoring. The idea is that by opening up several different bank accounts (revenue, operating costs, profit, taxes, etc) and using pre-defined percentages of income to allocate into each of them, we will better manage our money and not overspend.
Simple, right? Let’s dive into it.
What I Love About Profit First
There are definitely things I think are great about Profit First. The focus on intentionality with our money is critical, as is the idea that we should have a predetermined plan for where our money goes. When we aren’t intentional about where our money is going in our business (or in our personal lives, for that matter), we are more inclined to overspend.
Following a system like Profit First forces you to make a plan and really think about where your money goes. This is always the very first step in taking control of your finances: making an intentional plan of action.
I also love the so-called flipping of the “equation” that Michalowicz mentions in the book. Business owners (and accountants) tend to think about our business finances using this equation: Revenue – Expenses = Profit. But the problem with this equation, as Michalowicz points out, is that it means business owners end up with the “leftovers.” Very often, after all expenses, there isn’t much left at the end of the day to pay the owner of the business.
I see this problem all the time. Business owners that work like crazy pouring their time, energy, and money into their business, when, at the end of the day, are barely able to pay themselves a living wage from their business in return. This leaves many business owners wondering whether their effort is worth it or whether they’ll be forced back into a corporate job in order to make ends meet.
Michalowicz flips this equation on its head and instead advocates for using this formula in your business:
Revenue – Profit = Expenses.
Ultimately, you first determine how much you want your profit to be and then you back into how much you have available to spend for a particular period of time.
Why is this a smart idea?
Well, we’re back to intentionality here. In this case, you start first by deciding how much you want to profit in your business (i.e. the amount available to distribute to yourself as the business owner) and THEN figure out how much money you can spend IN the business while still being able to make this happen. This idea didn’t originate with Michalowicz, of course. This is a common approach used by big businesses who set profit targets first and then create departmental spending budgets with the overall goal in mind. Michalowicz simply brings this idea to small businesses in an actionable way.
But alas, a great plan is only as good as the ability to implement and stick to it. To help with this, Michalowicz advocates for opening a multitude of different bank accounts, sometimes even across banks, in order to make it harder to withdraw the money you’ve set aside for yourself. This is evidently in an effort to keep us from sabotaging ourselves, but is also where I start to diverge from the Michalowicz line of thinking…
Where Profit First Falls Short
The bank account structure of Profit First can be overwhelming and overly complex to keep up with and doesn’t really speak to how many business owners manage their money to begin with. Michalowicz seems to believe that before making purchases, people are simply checking their bank account to see if enough money is there. If the money is there, they make the purchase. If it isn’t, they don’t. However, our spending habits aren’t always so black and white. In reality, many business owners are using credit cards and other lines of credit to make purchases even without cash in the bank.
Managing five to eight different bank accounts is also cumbersome and can lead to unintentional balance shortfalls if not watched exceedingly closely.
One thing I’ve heard from those who attempted Profit First is that despite their best efforts, they often ended up having to pull from other accounts, like their Profit or Tax account, to cover general operating expenses in their business when their operating account didn’t have enough. This obviously defeats the purpose of the Profit First system and simply makes for a cumbersome shell-game of moving money around in order to pay bills.
Why does this so frequently occur?
Well, it’s because of what Profit First IS and ISN’T. The Profit First method is a great way for already financially fit companies to become more intentional about their use of funds. They do this by helping them cut expenses in favor of paying themselves more. Profit First is NOT a system that will help a less than financially fit company magically become flush with cash. It won’t fix your pricing issues and it won’t tell you WHICH expenses you shout cut and which you should keep. It also doesn’t really focus on how to effectively use cash to GROW your company. In fact, instituting Profit First, at times, has stunted growth of companies that may have been better off by reinvesting more of their cash into the business and obtaining a return that yields to a bigger paycheck for owners in the future.
Does that make Profit First a bad system? No, not at all. It just isn’t a COMPLETE system to manage your business finances…nor was it likely intended to be. The premise of Profit First is actually great. The problem is that business owners have begun to look to the Profit First system as the only thing they need to successfully manage the money in their business.
So, do I recommend Profit First?
Yes, I do recommend having a system like Profit First for intentionally paying yourself, saving for taxes, and meeting your other business and personal goals. Although I do think the idea that this can only be done by opening up a plethora of bank accounts is a little outdated and may be overcomplicating matters more than necessary.
However, BEFORE an entrepreneur can implement a system like this, they need to make sure that the business is financially fit first. That means looking deeply at the prices they are setting for their products and services and intentionally setting and managing profit margins.
It also means understanding which costs are worthwhile to keep, and even increase spending on in some cases, and which costs can and should be reduced or eliminated. Overall, it is getting SUPER real with yourself as the business owner and considering your own goals, priorities, and drivers in your business and personal life. There is no one-size-fits-all system you can implement that will fix all of your financial woes.
The perfect financial management system for your business is one that YOU create and personalize for yourself. It’s one that releases you from the stress, overwhelm, or even avoidance of your finances and helps you LOOK FORWARD to looking at the numbers side of your business (as unlikely as that may sound)!
If you’re interested in what this looks like, join my waitlist for Financial Fitness Formula™, enrollment beginning soon! This program will walk through all the key areas of financial management like picking the right price, managing profit margins, short-term budgeting and long-term forecasting and help you create and implement your OWN formula for financial success that aligns with who you are and the business you want to have. Our system can be used successfully on its own or in conjunction with Profit First bank balance accounting.
Overall, the key is to have an A to Z financial system set up to help you meet your goals.
To learn more about Jamie Trull and Balance CFO LLC, visit our website here. You can also join her free Facebook Community, “Financial Literacy for Women Business Owners” to connect with other small business owners here, and subscribe to her on YouTube for weekly educational training .
Looking for a Bank to use with Profit First Methodology and has auto-transfer rules to put your Profit First Allocations on autopilot? We recommend Relay! Learn about why we love them and get started today here!