As a freelancer struggling to get off the income rollercoaster, I was skeptical at best when I first cracked open Profit First: Transform Your Business From a Cash-Eating Monster to a Money-Making Machine by Mike Michalowicz.
“You’ll help my business start being profitable today? Lol ok, Mike”.
But let me tell you, Profit First has been a complete game-changer in my business and life.
If you’ve been doing everything you should be doing in your business but you’re still not seeing profitability, this issue may be with the system you’re using to manage your finances. Rather than subtracting expenses from sales and calling it profit, the Profit First method flips this on its head by challenging you to take your profit first.
Sounds crazy, right? Implementing this process will require a shift in your mindset. It will also force you to take a cold, hard look at your financial situation, to stop doing things that aren’t working, and to start turning a profit immediately.
Here’s how it works…
Step 1: Get real about your financial health.
Don’t mistake income and profit. Your business isn’t necessarily healthy just because you’re bringing in lots of cash. If your business is leaking money all over the place, you won’t stay afloat for long so step one is to get real with yourself about your business’ financial health. If you don’t start taking your financial security seriously, you run the risk of lulling yourself into a false sense of security and then being screwed if there’s a dip in sales.
Do you have enough to cover yourself if you have a couple of bad months? Are you stuck living check-to-check because generating more revenue has also incurred more bills? Is there a way to be doing things more efficiently? These are all important questions to ask yourself. Profit First includes an assessment outline that can help bring clarity and highlight areas that need adjustment.
Step 2: Open separate bank accounts.
Parkinson’s law states that “work expands so as to fill the time available for its completion”. Something similar often happens with money – the more you have, the more you’ll spend. That’s why the core principle of Profit First is to split up what’s coming in from the start so you know exactly how much you have to spend at any given time. This is done simply by setting up separate bank accounts. While going to the bank and asking to set up multiple accounts may seem like a hassle, it will be well worth it.
Michalowicz recommends setting up accounts for Income, Profit, Owner’s Compensation, Taxes, and Operating Expenses. These are good guidelines to have. Still, you should create the structure that works best for you and your business based on your priorities and needs. For example, my system is set up with Income, Bills, Savings, and Tax accounts. A word to the wise, it’s best to set these up as checking accounts so that you can easily move money between them.
Step 3: Allocate a percentage of each payment.
Now, you’re going to move a particular percentage of all the money you make into those accounts as it comes in. The financial health assessment Michalowicz includes in Profit First can help you determine which percentages will work best for you. The key is to start small and adjust if needed rather than to set the percentages so high that they’re unsustainable.
I made things simple on myself in the beginning. I started by moving 15% of everything coming into my Income account to my Tax account. Then I moved 1% to my Savings account (which is my version of a Profit account). Just 1% of each paid invoice or purchased product may not seem like much at first, but it adds up. You’ll have a profitable business from the day you start setting it aside.
One key caveat is that the money put into the Profit account is meant for you to enjoy as a reward for your hard work and should NOT be reinvested in your business. If you’re doing that, you need to go back to assessing your business’ financial health to see where you can tighten things up so your business runs more efficiently.
Step 4: Don’t cheat.
This system only works if you actually follow it. While it might be tempting to transfer a smaller percentage or dip into other accounts to cover expenses during a bad month, don’t do it! If it’s really not sustainable, there are two things you need to do. First, reevaluate the percentages. Then, set a more realistic target and make changes in your business to fit the amount you have allocated for a budget. If it’s not working, you should take this as a warning sign that your business isn’t as healthy as it could be. Ignoring that and taking money from your other accounts will only be a patch rather than addressing the real problem and will ultimately hurt you in the long-run.
The best part about this system is that it doesn’t just work for business. It can also be applied to your everyday finances. Since putting this system into place six months ago, I’ve paid off more of my student debt than I’ve paid off in the last six years. I've started saving for the future. I feel fully prepared for tax season because I know I have everything I need for it in the bank. I’m not making more money than I did before; I’m just managing it better.