What is Profit First?

You started your business so that you could be your own boss and make your own money, right? You’re good at what you do and more importantly, you enjoy it. But why is it that you find yourself in the red year after year? Many small business owners struggle with these same questions and go round and round trying to make their business profitable. In this blog we will explore what it means to put your profit first and how it can change how you run your business. 

Traditional Accounting

Before you can understand the Profit First method, you must have an understanding of how traditional accounting systems work. A traditional profit formula deducts expenses from income, leaving the difference between the two as profit. However, this profit does not typically reflect the actual cash remaining nor the amount that the business owner has taken for themselves. Often times the end of the year rolls around and business owners reflect a profit, yet have no answer to where that money went or how they are going to pay taxes on that profit. This is where Profit First comes into play. 

What is Profit First?

Profit First is a nontraditional accounting method created by Mike Michalowicz in which business owners take a percentage of income or sales as profit, BEFORE deducting any other business expenditures. This method flips the script on how business owners typically think about accounting and budgets by requiring the business to be profitable while assisting business owners in adequately preparing for tax liabilities. 

How does Profit First Work?

Profit First begins with an assessment of your current financial state. You will need to look at how your business funds are allocated amongst the following five categories: Income, Profit, Owner’s Pay, Taxes, and Operating Expenses. After assessing your current state, you will need to decide the percentages of allocation that you would like to aim for moving forward. A typical recommendation for small businesses would be:

• Profit – 5%

• Owner’s Pay – 50%

• Tax - 15%

• Operating Expenses – 30%

Once you have decided on your Profit First Allocations, you will need to create bank accounts for each category. Next, determine appropriate allocation dates for your business to use, keeping in mind the typical trends of your cash flow. Begin depositing all sales into your Income account on a daily basis. On your determined allocation date, transfer all funds that have accumulated in the Income account to the corresponding accounts using your Profit First Allocations. On those same allocation dates, pay all bills from your Operating Expenses account and salaries for the business owner from the Owner’s Pay account. On a quarterly basis you may pay your estimated tax liabilities from the Tax account and distribute a percentage of profit to owners from your Profit Account. 

Why Profit First?

Using the Profit First method of accounting helps small business owners ensure that they are profitable and readily prepared for upcoming tax liabilities. The process assists owners in adequately budgeting and more importantly, ensuring that they get paid on a regular basis. Implementing Profit First into your small business may be just the change you need in order to get yourself out of the red and into the green while actually enjoying owning and managing your business!