Financial management: A breakdown of the method Profit First
Small business owners often struggle to manage their finances effectively, which can lead to financial stress, cash flow problems, and even business failure. However, there is a financial management system that is gaining popularity among entrepreneurs that can help them overcome these challenges.
You might have heard from it. It’s called Profit First and was developed by Mike Michalowicz, a successful entrepreneur and author of several books on business and finance.
What’s interesting about it, is that anyone can apply this to their business at any stage. It’s easy to understand and takes into account principles like tithing.
Ready to explore this method of financial management?
Let’s go!
What is Profit First?
The Profit First system is a cash management system that is designed to help small business owners manage their finances in a more effective and efficient way.
The basic premise of the Profit First system is that you should allocate revenue to different accounts based on specific percentages.
These accounts include a Profit account, a Tax account, an Owner's Compensation account, and an Operating Expenses account. You could also add a Tithing account or any account to your liking.
The goal of the system is to prioritize profitability by ensuring that profits are taken out of the business first, rather than being left to chance after all other expenses are paid.
How does the Profit First system work?
The Profit First system is based on four key principles.
The first principle is that you should prioritize profits by taking them out of the business first.
To implement this principle, you should set up a Profit account and allocate a percentage of your revenue to it. The recommended percentage is 5%, but it can be adjusted based on the needs of the business.
This account is off-limits for spending and is used only to accumulate profits.
The second principle of Profit First is that you should set aside money for taxes. This is important because many small business owners fail to plan for taxes and end up with unexpected tax bills that can be difficult to pay.
To implement this principle, you should set up a Tax account and allocate a percentage of your revenue to it. The recommended percentage is 15%, but it can be adjusted based on the needs of the business. This account is used only to accumulate funds for tax payments.
The third principle of Profit First is that you should pay yourself first. This means that you should prioritize your own compensation before paying any other expenses.
In order to do this, you should set up an Owner's Compensation account and allocate a percentage of revenue to it. The recommended percentage is 50% but it can be anything.
The fourth and final principle of Profit First is that you should manage your operating expenses based on the revenue that is left after profits, taxes, and owner compensation have been taken out of the equation.
You should set up an Operating Expenses account and allocate a percentage of your revenue to it. The recommended percentage is 30%.
As a Christian solopreneur, you might want to add another account to which you allocate a percentage. For many Christian business owners who use the Profit First system, the profit account is either used for the purpose of tithing or a special tithing account is created. Either could work.
What are the benefits of the Profit First system?
The Profit First system offers several benefits:
Increased profitability: By prioritizing profits and taking them out of the business first, you are more likely to achieve profitability
Better cash flow management: By allocating revenue to different accounts, you can better manage your cash flow and avoid cash flow problems
Improved financial visibility: By having separate accounts for profits, taxes, owner compensation, and operating expenses, you can get a clearer picture of your financial situation
Reduced financial stress: By having a system in place for managing your finances, you can reduce your financial stress and worry
Simplified financial management: The Profit First system simplifies financial management by breaking down revenue into specific percentages that are allocated to different accounts
More effective decision-making: By having a clearer picture of your financial situation and cash flow, you can make more effective decisions about your business
Increased accountability: The Profit First system encourages you to be more accountable for your financial management by setting specific targets for each account.
How can you implement the Profit First system?
Implementing the Profit First system is relatively straightforward. You can follow these steps to
get started:
Determine the revenue allocation percentages for each account (Profit, Tax, Owner's Compensation, Operating Expenses, and potentially Tithing)
Set up separate bank accounts for each account
Allocate revenue to each account based on the predetermined percentages at a specific time each month
Use the Profit account only for accumulating profits, the Tax account only for accumulating funds for tax payments, the Owner's Compensation account only for accumulating funds for owner compensation, and the Operating Expenses account only for covering all other operating expenses
Monitor and adjust the allocation percentages as needed
If you work with a bookkeeper either teach him/her the method or find one who is familiar with it. Many bookkeepers know about this method or are willing to learn and implement it.
Conclusion
The Profit First system is a simple but effective cash management system that can help small business owners prioritize profitability, manage their cash flow more effectively, and reduce financial stress. However, it’s just one way of managing your finances. Figure out if this is the way to go for you or if God has another way for you to manage your finances.
If you want to know more about this method and hear an expert talk about it, listen to episode 50 of the Born to Fly podcast with Rocky Lalvani.
