Profit First is a great book by Michael Michalowicz. This book encourages business owners to prioritize profit that they are trying to generate, before considering expenses and revenue. From that profit number, which should include paying yourself, they work backward. The idea is to ensure that the business is profitable and that the owner pays themselves adequately. We know that many small business owners don’t pay themselves as much as they should. They are also not earning the profit they should. But if we use this system as a way of backing into a good profit goal, then it will help significantly.
The system includes these goals:
- Prioritize Profit: Allocate a percentage of your revenue to profit first.
- Separate Accounts: Set up multiple bank accounts for different purposes (e.g., profit, taxes, operating expenses). You could have 4-5 Bank Accounts.
- Regular Transfers: Transfer money into these accounts regularly, typically at the end of each month.
- Discipline: Avoid dipping into these accounts for non-designated purposes to maintain financial discipline.
This method can help ensure that business owners pay themselves fairly and maintain a healthy profit margin. However, it does require diligent bookkeeping and discipline to avoid misusing the funds.
A Word of Caution
Many times, I’ve seen a business owner do quite well for the first six months of the year, then as a reward they decide to do something special as a bonus. They may take their family on a vacation or buy that car they’ve always wanted to have. But they actually take money out of one of these special accounts which totally negates the whole program. Therefore, this will work for you if you're great with detail, have good self-control and love the idea of dividing up the money so it's there when it comes to paying taxes or for you to buy a car at the end of the year. In this case, profit first is a wonderful method for you and certainly is something that every small business owner should think about so they have enough money to cover their expenses and to pay themselves as they should.
The Hoarding Method
My preferred method is what I call “the hoarding method.” This means that you have just one bank account and you hoard cash until the end of the year until Thanksgiving at which time you see how much cash you need to pay your taxes and for any unexpected bills to make sure that your cash is available for foreseeable expenses. After that, if there's still additional cash, go ahead and use it for something that you want. Take that vacation with your family or purchase that new car.
In Conclusion
Whether you choose the structured approach of the Profit First method or the more flexible Hoarding Method, the key is to find a system that works best for you and your business. Both methods emphasize the importance of financial discipline and ensure that you, as a business owner, are adequately compensated for your hard work. By prioritizing profit and maintaining a clear strategy for managing your finances, you can achieve a healthier, more sustainable business.
Need help sorting through your expenses, classifying them or determining if you are profitable? BudgetEase can help! Contact us.
