Have you ever heard of the cash envelope system for family budgeting? You’ve probably heard people like Dave Ramsey and others in the finance space teach a method of managing the family finances by allocating money into different envelopes for different purposes and paying cash for things like food, gas, and tithing, but it’s a system that has been around for decades.
From our grandparents who lived through the Great Depression and survived World War II keeping money in jars and steel boxes, to our moms who used their budgeted money in paper envelopes at the grocery store each week, this system has been adopted throughout the world to answer one specific need we have as humans: to feel secure in our money management and know that we had the cash needed to pay for the expenses we acquire.
Profit First is, in part, a modernized envelope system for businesses using bank accounts for allocation instead of physical containers, and it’s one that you can apply to your business too.
Setting up these five bank accounts is the first step to implementing the Profit First system. It gives your business the financial structure by removing the profit first so you operate on less.
How do the different bank accounts work?
Profit First is based on five separate bank accounts that once you set up for your business, you’ll have set up a foundation strong enough to handle the upcoming structure of your money management.
The five checking accounts you need to set up are:
- Owner’s Comp
Profit First also encourages you to set up two additional “no temptation” accounts in a separate bank entirely so that you can shuffle money from your initial “profit” and “tax” accounts to second “profit” and “tax” accounts at a separate bank so it is even more inaccessible to your general use than the 5 accounts at your primary bank. More on that a little later.
What if I’m used to bank balance accounting?
That’s totally okay! Bank balance accounting is just another term that Mike Machalowitz uses in his book for the typical cash management system that we as entrepreneurs usually default to.
In a perfect world, we as business owners would use our accounting system (Quickbooks, etc) to figure out where the money is going and how much money we have where, but reconciling all the accounts for accuracy, reviewing Profit & Loss and cash flow statements, then running all the metrics to determine KPI is really a drag for a CEO and visionary. After all, that’s probably why we hired someone to do our bookkeeping and accounting in the first place. Maybe some of us are numbers-aware enough to do all that, but for the most part, no.
So instead, business owners typically log into their bank accounts, make note of the balances, and based on what they see there, make decisions regarding budget and spending.
When the balance is low, we do a hard push for sales and other revenue-generating activities. When the balance is high, we are likely to invest in expansion.
It kind of works, but it’s reactionary. It’s based on our gut, what we see, and what we think we want at the moment. It kind of works but it seems as though we never have enough money left over to pay ourselves because we’re always making those other kinds of decisions first, never to pay ourselves.
That’s where the Profit First method and all its bank accounts come into play. It’s designed so that you can still do your bank balance accounting. You can still check what’s in each envelope, know what the money’s for, and make decisions based on where the business needs to go. It just takes out the profit allocation FIRST so while you have less to work with, you’re always still stashing away cash.
What’s the point of the no-temptation accounts?
Just what the name suggests: to keep you from touching it. 🙂 Your initial collection of five checking accounts includes a profit and tax account, sure, but if we were to leave these accounts as-is, holding all the profit and tax, and leave us to our own devices, it would be pretty easy for us to shuffle some money around at the first sign of a pinch or so-called crisis. Even though these accounts are labeled “profit” and “tax” to reorganize the cash flow initially, the accounts as-is don’t hold the power to keep us from checking the balance and moving money to pay bills or payroll during times we felt we needed to.
Setting up secondary accounts to hold the money long-term ensures that profits stay where they belong and also that tax funds are available to pay Mr. Taxman when the time rolls around… which it always does.
What kind of bank should I choose?
For the initial five accounts that you’ll need access to daily, choose a bank or financial institution with lots of convenience options. You want it to be easy to view your accounts (you know, your envelopes), transfer money between them, and pay bills from OPEX.
However, for the no-temptation accounts, choose a bank with very few convenience options. Remember, you want it to be hard and not fun to access those long-term hold profit and tax accounts. Out of sight, out of mind. We want the profit and tax accounts to keep growing, not to be available for reactionary decisions when we as the visionary want to up the marketing budget or need to cover extra labor expenses.
Remember, banks won’t always be set up to work with what you need or are asking for. Look for one that WILL accommodate your requests and be happy to have your business. And if you started with a bank that ends up not being a great fit, you can always change banks for one that facilitates a better relationship with you as the business owner.
To sum up, these are the three steps you need to take action on to get your business profit-ready:
Step 1. Set up the five foundational checking accounts: an INCOME account, a PROFIT account, an OWNER’S COMP account, a TAX account, and an OPEX account.
Step 2. Set up two more external savings accounts in a secondary bank that holds your no-temptation PROFIT and TAX accounts.
Step 3. Don’t enable any of the “convenience” options for your no-temptation accounts because for now, all you want to do is use them to deposit and hold your profit and tax reserves.
The different bank accounts aren’t meant to change behavior as much as put guardrails around it. You will want those parameters to protect you from yourself (for times when the business cash flow might be down, or expenses might be up).
The end result? You’ll have an easy way to manage and move around your money between the respective envelopes, your no-temptation profit account will start growing (even though you won’t have eyes on it yet to watch progress), your tax account will have the funds needed to cover tax day, and it will feel so good to start paying yourself! Growing profit, growing your business, one day at a time.
Ready to take your first step toward putting profit FIRST in your business?
I challenge you today to start taking your profit first. Starting with your next deposit, save 1% of that deposit into a saving account and watch that account begin to grow with each deposit. This is the first step of your profit journey, Congratulations! Share your profit wins with us at email@example.com!
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