Profit First: The Shocking Truth About Small Business Profitability

introduction:

If you’re a small business owner struggling to turn a profit, you may have heard of the Profit First system developed by entrepreneur and author Mike Michalowicz. The system involves allocating a percentage of revenue to specific accounts for operating expenses, profit, owner’s compensation, and taxes. While the system has gained a lot of popularity among small business owners, it’s important to understand how it works before implementing it in your business.

How the system works:

1. Set up separate bank accounts: To implement Profit First, you’ll need to set up multiple bank accounts for your business. Each account will be used for a specific purpose, such as operating expenses, profit, owner’s compensation, and taxes.
2. Determine the percentages: Once you have your bank accounts set up, you’ll need to determine the percentage of revenue that should be allocated to each account. The percentages will depend on your business’s size and industry, but a general guideline is to allocate 5% to 15% for profit, 50% to 60% for operating expenses, 30% to 35% for owner’s compensation, and 10% to 15% for taxes.
3. Use the accounts accordingly: Once you’ve allocated the percentages, you’ll need to use the accounts accordingly. For example, the operating expenses account will be used to pay for your business’s day-to-day expenses, while the profit account will be used to pay yourself a bonus at the end of each quarter.

Core bank accounts

The core accounts we suggest are as follows:

1.  Income account
2. Profit account
3. Operating expense account
4. Payroll account
5. Tax account

Income account:

• —ACCOUNT USED TO RECEIVE MONIES FROM CLIENTS
• —ACCOUNT NUMBER WILL BE THE ONE ON THE INVOICES
• —ACCOUNT WILL BE USED SOLELY FOR TRANSFERRING TO OTHER ACCOUNTS
• —EMPTIED EVERY 7TH AND 21ST OF THE MONTH

Operating account:

• —STANDARD CHEQUE OR SAVING ACCOUNT
• —TRANSFER TO THIS ACCOUNT IS BASED ON A PERCENTAGE LESS PAYROLL
• —TRANSFER MADE EVERY 7TH AND 21ST OF THE MONTH
• —IF THE ACCOUNT IS EMPTY THEN THE BUSINESS CANNOT AFFORD THE NECESSARY EXPENSE. WE NORMALLY USE THIS ACCOUNT WITH ZBB METHOD. THE ARTICLE ON ZBB CAN BE FOUND HERE

Payroll Account:

• —TRANSFER TO THIS ACCOUNT BASED ON A PERCENTAGE
• —HAS TO BE AN ACCOUNT THAT PAYMENT CAN BE AFFECTED FROM (STANDARD CHEQUE OR SAVINGS ACCOUNT)
• —TRANSFER MADE EVERY 7TH AND 21ST OF THE MONTH 
• —PAYMENT MADE 25TH OF EVERY MONTH
• —ADDITIONAL FUNDS TRANSFERRED TO PROFIT ACCOUNT EVERY 6 MONTHS.

Profit account:

• —HAS TO BE A 7 DAY NOTICE ACCOUNT
• —TRANSFER TO THIS ACCOUNT BASED ON A PERCENTAGE (3% IN THE BEGINNING WITH A TARGET OF 15% TRANSFER)
• —TRANSFER MADE INTO ACCOUNT EVERY 7TH AND 21ST OF THE MONTH
• —DIVIDENDS PAID EVERY 6 MONTH IF THE ACCOUNT IS ABOVE A CERTAIN THRESHOLD (ENOUGH FUNDS TO PAY PAYROLL FOR 6 MONTHS)
• —FUNDS SHOULD NEVER BE USED TO PAY OPERATING EXPENSES.

Tax Account:

• —ACCOUNT HAS TO BE A 7 DAY NOTICE ACCOUNT
• —TRANSFER TO THIS ACCOUNT IS BASED ON TWO PERCENTAGES (15% FOR VAT AND 27% FOR INCOME TAX) 
• —TRANSFER MADE EVERY 7TH AND 21ST OF THE MONTH
• —PAYMENT MADE EVERY 6 MONTHS (INCOME TAX). READ MORE ABOUT THESE PAYMENTS HERE
• —PAYMENT MADE EVERY SECOND MONTH (VAT)

Benefits of the profit first system:

• —Prioritizes profitability: One of the biggest benefits of the Profit First system is that it prioritizes profitability. By allocating a percentage of revenue to a profit account, you’re incentivized to focus on increasing revenue and finding ways to trim expenses. This can lead to better financial health for your business in the long run.
• —Encourages better financial management: The Profit First system requires you to set up multiple bank accounts and allocate funds accordingly. This encourages better financial management and helps you stay on top of your cash flow. It also makes it easier to monitor your expenses and ensure that you have enough money to cover your bills.
• —Helps you avoid debt: By prioritizing profitability and setting aside funds for taxes and other expenses, the Profit First system can help you avoid taking on debt. This can be especially beneficial for small businesses that may not have access to a lot of capital or credit.

Drawbacks of the profit first system:

• —Can be time-consuming: Setting up multiple bank accounts and allocating funds to each account can be time-consuming, especially if you’re not familiar with financial management. This can be a drawback for small business owners who already have a lot on their plate.
• —Requires discipline: The Profit First system requires discipline to work effectively. You need to stick to your allocations and resist the temptation to dip into other accounts. This can be a challenge for some business owners who struggle with financial discipline.
• —May not work for all businesses: The Profit First system is designed to work for small businesses, but it may not be the best fit for all businesses. Depending on your industry and business model, you may need to allocate funds differently or use a different financial management system altogether.

CONCLUSION:

Overall, the Profit First system can be a great tool for small business owners looking to prioritize profitability and better manage their finances. However, it’s important to weigh the benefits and drawbacks and understand how the system works before implementing it in your business. If you’re not sure whether the system is right for you, consider talking to a financial advisor or accountant to get their perspective.

The video below explains the above with examples for you.

More from the practice.