Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine


no title has been provided for this book
Publisher: Portfolio
Published: 2/21/2017
Conventional accounting uses the logical (albeit, flawed) formula: Sales - Expenses = Profit. The problem is, businesses are run by humans, and humans aren't always logical. Serial entrepreneur Mike Michalowicz has developed a behavioral approach to accounting to flip the formula: Sales - Profit = Expenses.

Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine

Key Insights

If you’re like many small business owners, financial freedom is probably one of the reasons you went into business for yourself. Not having to rely on someone else to cut you a paycheck, no limit on what you can earn... that’s the dream! Ironically, though financial freedom is what many of us are searching for, it's incredible how quickly you can get bogged down and stressed out by managing expenses when you start a small business. Mike Michalowicz, the writer of Profit First, has a solution to dealing with financial burdens: putting profit first. Read on to discover how putting profit first can be game-changing for your small business, how it can help you to get out of the survival trap, and why adhering to the standard formula for determining profit might be holding you back.

Get out of the Survival Trap

Many people who start businesses find themselves caught up in what the author calls “The Survival Trap”. The trap often starts with not having enough money to cover expenses, which leads to trying to generate income at all costs: often at the expense of the business’s integrity or future goals. Even if it means taking on shady clients, or creating/advertising products they don’t want to sell. Eventually, they get stuck with the consequences of these practices. They start making poor decisions due to stress, develop a roster of bad clients, and lose touch with the vision they once had for their business. Business owners caught in this trap can become enslaved to their business, often while not prioritizing their own pay… which means they’re stressed and broke. Efficiency can never become a priority when a business is in a constant state of crisis, which means sadly, the crisis will often repeat itself. Not to mention they don’t have money in their account for the projects they would really like to do, and they can feel as though they’re inching towards a nervous breakdown. A total nightmare! There is a better way! But first….

Profit Needs to come before your ego

Though author Mike Michalowicz was a very successful business owner, he lost everything due to one fatal mistake: letting his ego get the best of him. The day he received a $388,000 check for one of his super successful companies that were being sold to a Fortune 500 firm was the day he, according to his book, lost his mind. His ego got massive and he began funding start-up after start-up, with each one failing until he had only $10,000 to his name. Moments after this realization, his accountant told him he owed $28,000 to the IRS and a $2,000 fee for doing his taxes. Financially, he hit rock bottom. He had nothing. While he was down there, he realized that he had been structuring his businesses ineffectively, for a variety of reasons, but with his unchecked ego in the driver’s seat, he just couldn’t see it. From his financial failure, he realized that profit needed to be the top priority, before absolutely anything else, even his ego.

People make a lot of mistakes when growing their businesses, but not putting profit first is the most fatal. In order to do this, you’ll need to change the way you think about profit entirely.

Change the way you think about profit

Most business owners have heard of GAAP Formula for Determining Profit

Sales - expenses = profit

Slightly altering this formula gives you:

Sales - profits = expenses

This formula is a representation of taking your profit first. Remove your profit from your sales generated income, and you’ll know the amount you have left to spend on expenses. Pretty simple, right? Take out your profit FIRST, and then see what you have left. There’s your budget for your expenses. But why does this work?

Parkinson’s Law

Parkinson’s law states that whatever amount of a resource is allocated to us, will become the amount that we need. For instance: if you are given 2 weeks to complete a project, the time needed to complete the project, regardless of how long it might take without the deadline, will become two weeks. If we apply Parkinson’s law to the GAAP formula for determining a business profit, we see that if we are taking our profit out first, instead of our expenses, we can control how much we spend on expenses. If we make $40 in sales, decide we are taking $20 our for-profit, we now have $20 allocated to expenses: and we will have to make our expenses fit that amount. In the old system, business owners are taking expenses directly from revenue, with little to no control or awareness of how much this would leave for profit. Profit should be the first thing you think of, the first thing you take out of sales, and the first thing you focus on in every avenue of your business. It seems simple enough, right? But how can we maintain this system?

Avoid bank balance accounting

The discipline involved in making tough calls is exhausting, and like a muscle, the part of you that maintains discipline can become drained. This is why it is important to work with your natural tendencies when it comes to saving money, instead of trying to discipline yourself into being more frugal. One way you can do this is by avoiding “Bank Balance Accounting”. Many business owners check their bank balance multiple times a day and use this to determine how much they can spend. There are many potential problems with this like potential pending transactions, or bills they have yet to pay but may have forgotten about. To get out of this habit, move part of whatever ends up in your bank account to another account marked “Profit”. When the amount in your bank account changes (thanks to Parkinson’s Law), you will automatically adjust your spending accordingly. This will give you opportunities (and motivation) to innovate and to eliminate spending that is unnecessary.

Just take 1% (until you’re ready to kick it up a notch)

At the bare minimum just take 1% of any income you generate and put it into a savings account. If your business can run at $1,000, it can definitely run on $990. In this instance, you’re still taking your profit first, and you might be surprised by how quickly the account builds, even from taking such a minimal amount.

However, if you’d like to step it up:

Follow these steps:

Step 1: Go to your bank and set up four accounts

Owners Pay Account, Profit Account, Tax Account, Operating Expenses Account.

Determine your owner’s pay based on how much people like you usually make in your industry. The other expense accounts should also be based on how usual industry practice, as well as personal experience with how much your business tends to owe.

Step 2: Go to another bank and set up two more accounts

No Temptation Profit Account

No Temptation Tax Account

These two accounts should be difficult to access. This will keep you from transferring money out of them in case you get into a bind.

On the first day of each new fiscal quarter, take half of your profit account, and leave the rest as a reserve. Use your tax account to cover any tax payments that may arise.

Focus on Profit, not GROWTH

Business owners can become extremely focused on growth: meaning that all of their energy goes into hooking bigger clients, expansion, or many other things. Here’s the thing: this mindset just doesn’t work. The author states that growth is half of the equation when it comes to creating a successful business: while often business owners see it as the most essential aspect. They will expand their businesses, hoping that they’ll make enough after expanding to make up for the expansion. This is backward. Jason Fried, the co-founder of Basecamp, wrote about his favorite Chicago pizza joint. The owners had done everything perfectly, but they were more focused on expansion than selling pizza (or profiting). Because they weren’t focused on bringing in the dough (ha!), they eventually went out of business. Avoid this by putting your energy into making your business as profitable as possible. If you focus on profiting, growth will happen naturally. Business owners often wonder about how big to make their business: how many employees they will need to hire, and how much office space they will need. This is another aspect of growth that will be resolved if you focus on profit first: focus on the money and your business will size itself.

If you’re having one of these two responses, it is ok!

There are two main responses entrepreneurs have when taking the steps towards implementing the Profit First System. First, they may find themselves paralyzed by overanalyzing the details, and unsure of what move to make next. Conversely, they may jump headfirst into using the Profit First System, and taking action too big and too fast. If you find yourself paralyzed into inaction, it is ok. And if you’ve taken the full leap, that’s good news: but be ready for a slow and steady build. This system is comprised of slow and steady steps: not giant leaps.

Summary

If you’re like many small business owners, financial freedom is probably one of the reasons you went into business for yourself. Mike Michalowicz, the writer of Profit First, has a solution to dealing with financial burdens: putting profit first. Read on to discover how putting profit first can be game-changing for your small business, how it can help you to get out of the survival trap, and why adhering to the standard formula for determining profit might be holding you back.

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