Part of what makes Profit First simple to understand and relatively easy to implement is how it nods to the envelope system of the past like many of our parents and grandparents used to manage their personal finances.
We’ve all had some experience with the envelope system, either personally using it or hearing about it from loved ones. Actually, it might have been the very first method you were taught for managing your allowance or chores money as a kid (one for spending, saving, and one for giving)!
Indeed, the basic premise of the envelope system is to designate percentages of your spendable money into “buckets” for necessities such as groceries, home goods, and gas, to money saved for fun, and money set aside for a rainy day.
However, once the money in one bucket is gone, you either have to accept it or make a conscious (often painful) decision to dip into money meant for another purpose.
The latter is always challenging, whether we’re talking about family finances or money in the business; dipping into another envelope means taking away from a different need or desire.
Profit First follows the same methodology for businesses but with a caveat; it protects you and your finances from temptation. Here’s how;
Like a modernized envelope system, Profit First, designed and created by Mike Michalowicz, teaches you to divide your finances into different bank accounts (instead of physical containers like envelopes) for fund allocation. All revenue that comes into the business gets reorganized into specific accounts based on spending, saving, profit, taxes, and operational costs.
Once the money is in its proper place, it makes it EASIER to actually save profit and harder to use the money for other needs thanks to different barriers in place that make it challenging to move money on a whim.
As we learned in the last blog post, the five foundational bank accounts that every business owner following the Profit First methodology should set up are:
- Owner’s Comp
Remember those no-temptation accounts that are hard to reach? Well, they are actually working to protect your assets and relieve you of the future stress of tax payments and that rainy day fund (Nod to the envelope system).
Consider it as another layer of accountability for you to save the profit and tax money while blocking any urge to dip.
But even more, these five accounts are not only the first step to finally seeing Profit in your business, but are necessary for the Profit First Method.
Okay, I understand the purpose behind using different accounts. But how do I go about allocating money each month?
Think of allocating funds in this way like a money “waterfall”. The allocation process first starts as all income flows into your top income account.
For example, on the 10th and 25th of each month (these dates are intentional to help you keep a scheduling cadence), you’ll spread the total revenue into your smaller accounts based on current allocation percentages, where your priorities lie with your business operating expenses, and how much profit you want to save in any given financial period.
How to determine your allocation percentages:
Current percentages are calculated when you complete the Initial assessment. This will show you how to slowly move your percentages up or down over a period of time based on your current spending. Using the Profit First Method is about a steady stream of small steps to ease the overwhelm and increase your profit-habit confidence.
Next, you’ll want to compare your numbers with target allocation percentages for a similar “healthy” business within your revenue levels to use as a baseline.
In general, these would be the target percentages that your rollout plan will guide you toward:
- Profit: 5% to 20%
- Owner’s Pay: 0% to 50%
- Taxes: 15%
- Operating Expenses: 30% to 65%
While these percentages will vary depending on your real business revenue, we can plug Profit First Simplified for the ease of assessing and creating the roll-out plan.
And just know that as you work through the big picture of your business finances – where you are now and where you want to go financially – these numbers can be customized to your own targets. That’s part of the beauty of Profit First. It provides a solid baseline and a proven methodology to customize it to your own personal and professional goals.
Next, it’s allocation time. Use the money that has accumulated in the income account to allocate to the proper account.
This semi-monthly rhythm is ideal as it enables a consistent 2-week schedule where you can pay all your bills from your OPEX once allocations are made.
Remember those extra special, more hidden profit and tax accounts in the second bank? Those funds are transferred to their accounts in a separate bank to get them out of sight and away from temptation. It’s like working the system to protect you from…yourself 🙂
How you can handle the end of the quarter:
Thankfully, there are different ways you can adopt to handle profit allocation at the end of every quarter. Depending on your goals and needs, 50% of whatever is in the PROFIT account can go to the business owner as a reward. These are your profit wins! And the other half could go to a long-term storage account to build three to six months of reserves. This is your rainy day fund.
Yet if you have any debt, you can take a small percentage of this profit as owner distribution and use the remaining 99% to pay down these debts.
Profit First really is the answer to making profit a priority and ensuring the long-term sustainability of your business.
Here are a few extra tips about Profit First to help you on your journey:
What is the overarching goal of basic allocation? To help you hit financial targets faster!
Want to increase the amount of savings the business has built up for capital investments? Allocating a slightly higher percentage to that account every month will help you do that.
Preparing for a more challenging tax season? Allocating a higher percentage for Uncle Sam will remove uncertainty and ensure you have plenty of available money to pay the bill.
Profit First gives you flexibility over where your money goes and real-time knowledge of where to adjust to see the biggest changes. Most importantly, it sets the default in your financial situation to save for profit – profit for you as the business owner, profit to save for investments, and profit to enjoy the fruits of your company’s labor. Whether that means you have the freedom to give more, invest more, or design a business that fulfills your life, this proven methodology can help you make that happen.
Yet if all this talk about allocation makes your head spin and you feel confused about what percentage should go where, you don’t have to do it alone and you can learn how to create your cash cow with a Profit First Coach.
Ready to take your first step toward putting profit FIRST in your business?
I challenge you to start taking your Profit First. Starting with your next deposit, save 1% of that deposit into a saving account and watch that account grow with each deposit. This is the first step of your profit journey, Congratulations! Share your profit wins with us at email@example.com!
You’re invited to reach out for a discovery call to see if you would be a good fit for one of our services or programs.
- If you would like to learn more about Profit First, visit our website.
- Also, complete your Profit First assessment to discover why it is the #1 tool for every business owner