Book Review / Profit First
A couple months ago, I did a roundup on IGTV of some of my favorite business books (you can watch it here) and in that video I mentioned that all of the books had blog posts to go along with them. It was only after I recorded and posted the video that I realized that I never actually wrote a blog on Profit First by Mike Michalowicz which was super surprising to me.
It’s probably one of the most helpful books that I’ve read as far as practical application, and I’ve been implementing the system in our business pretty much since the beginning. I’ve mentioned before that finances are not my strong suit and I need all the help I can get. The Profit First system has helped me to everything and give me peace of mind, but it also has helped us actually pay ourselves which is really hard to do when you’re first starting a business. So let’s dive into what I learned from this book and how I apply it.
The tagline for Profit First is “Transform your business from a cash-eating monster to a money-making machine.” The whole goal is to learn how to make your business profitable and make sure that you are seeing return from all the work that you put in. As a small business owner, it can feel impossible to actually pay yourself, and for most startups, all money goes directly into the cost of running the business.
Michalowicz has started several businesses as well as studied successful small businesses to try to figure out why they work. He says, “eight out of ten businesses fail, and the number one reason they fail is lack of profitability.” He talks about how he grew a “successful” business but was still living paycheck to paycheck and ended up losing everything. From personal experience and study, he found that the typical accounting system is broken. The usual formula is Sales - Expenses = Profit. His advice is to flip that on its head and take your profit first, hence the name of the book.
We tend to think that when we increase sales, our profit will increase as well, so we tell ourselves that once our sales go up, or we book more clients, we will finally be able to pay ourselves. In reality, when our income goes up, our expenses increase and we never actually see any return. More revenue does not always mean that your business is actually successful. We tend to focus on growth when we should actually be focusing on profit, figuring out what makes profit and getting rid of the things that don’t.
Michalowicz says that traditional accounting goes against human nature because, “no matter how much income we generate, we will find a way to spend it - all of it.” Traditional accounting teaches us to focus on sales and expenses which will cause growth in those areas since we grow what we focus on. If you only focus on business expenses and never or rarely pay yourself, you’re more likely to burn out. When you focus on paying yourself and rewarding yourself for all your hard work, you will be much more motivated to continue putting in the work to grow your business. After all, why are you even doing this if you never see any benefit from your hard work?
If you’re questioning how you can really grow if you set aside your profit first, listen to this: “what I’ve found is that the fastest, healthiest growth comes from businesses that prioritize profit. And it is not because they plow money back into their businesses. Businesses that plow back their profits aren’t truly profitable; they are just holding money temporarily (feigning profit), then spending it, just like any other expense.
Profit First sparks faster growth because it makes you reverse engineer your profitability. When you take your profit first, your business will tell you immediately whether it can afford the expenses you are incurring; it will tell you whether you are streamlined enough; it will tell you whether you have the right margins.”
Michalowicz dives in really deep into the broken system and how to fix it, so if this interests you, I highly suggest that you purchase the book and read it all for yourself. It’s way too much for me to cover it here, but his writing style is super easy to read, even if you don’t have a financial background and I highly recommend it. What I do want to cover is the basics of the system and how I customized it for Weekend Creative. There are four core principles of Profit First, and they actually go back to psychological principles used in dieting. It also reminds me of the envelope method that people use to budget their money.
Use Small Plates: if you put your food on a small plate, you will eat less and therefore lose weight. The same applies in the rest of our lives, when we have less, we use less and become more innovative. If you take your profit out first and leave your business with less money to run (a smaller plate), you will stop spending in unnecessary ways and become more creative in how you use the money you have. When money comes into your main account, it acts like a serving tray for other accounts and get divided up by category based on percentages that you set up.
Serve Sequentially: we place additional significance on what we encounter first. When we focus on sales and expenses, we think of profit as an afterthought, but “when profit comes first, it’s the focus, and it is never forgotten.” Take your profit first, break up your money according to the percentages you set, and eliminate all extra expenses.
Remove Temptation: out of sight, out of mind is a very powerful principle. When you take the profit out of checks that come in and put it away, you are less tempted to spend it on business expenses.
Enforce a Rhythm: “when we get into a rhythm, we don’t get into the reactive mode of crazy spending when we get big deposits and panicking in the face of big cash dips.” Michalowicz recommends breaking up your money twice a month, but I actually do it once a week because that works better for me.
Michalowicz recommends setting up five separate bank accounts, one for income, one for profit, one for owner’s comp, one for tax, and one for operating expenses. He also recommends that you make the taxes and profit accounts “no temptation” accounts by setting them up at a completely different bank but I haven’t found this to be necessary for us. What I love about this system is that it’s completely customizable. For us, I set up several accounts under the bank account that we already had. I also customized the accounts and set up ones that I felt like were more useful to us. The accounts that I have set up are:
Operating - This is where all our money flows in. I use this account to pay all our business expenses and pay our credit card.
Rent - This is where I set aside money for our rent. I wanted to have this account to also save rent money since I want to be able to pay at least three months of rent at any time.
Payroll - This is where I put aside money to pay ourselves every two weeks. You can choose to pay yourself whatever is in this account, but we choose to pay ourselves a salary that we set so that our income is more predictable.
Profit - One of the tips from the book is to put aside 5% of everything that comes in and give yourself a quarterly bonus. We do this and then give ourselves the bonus every time we pay quarterly taxes. It’s been amazing to see how significant 5% is and makes paying taxes a little more fun.
Tax Savings - This will help eliminate the inevitable shock of tax time. It’s recommended to set aside about 30-35% of your income for taxes, but you’ll want to look up the tax rate in your area and talk to your accountant about what they recommend. You’ll also learn over time what makes sense for your business.
Savings - I really like savings (can you tell) and so I put aside a little money from each check in case of emergencies. At the end of the year, I try to spend at least some of this, either to fully pay off our credit card or make a larger purchase to make our expenses larger for tax purposes.
You can think through your expenses and the way you use money and create your own system for breaking everything out. Michalowicz has recommended percentages, but I created my own based on what makes sense for us, and those change over time. I’m now putting more money into payroll than I was when we first started. The point is to build up to profit, you may not be able to put a huge chunk into profit right away, but as you cut expenses and grow, that percentage should increase.
I started actually using a budget for the first time this year and this system made it really easy for me to figure out how much money we could spend on business expenses. I started by taking our monthly income goal and then breaking it out by percentages. This gave me an idea of how much money would go into each account every month. I then could see how much we had staying in our operating account. I created a spreadsheet with all our expenses and how much they cost last year. I projected what would change or stay the same, and looked at how we can cut expenses as well as what we will be adding this year. I know it’s only February, but this has been really helpful so far to help us keep expenses down.
I really love that I know exactly how much money we have at one glance simply by looking at our bank account. It gives me so much peace of mind to know that we can pay ourselves and still pay all our bills. I think it also helps me to know exactly what to do with our money when it comes in instead of just spending it here and there. I highly recommend picking up a copy of Profit First because as I mentioned, there’s no way that I can do it justice in this blog post. Feel free to reach out to me if you have any questions about this!
Is is the weekend yet?
Elle