Should You Implement “Profit First” in Your Business?

If you’re a business owner you’re surely heard of the “Profit First” method and have likely wondered if it’s something you should implement in your business. Groupies tout it as the gold standard of running a business. The only thing that matters. The foundation you need. That Mr. Michalowicz is the messiah, if you will. In this post we’re going to go through real pros and cons (yes, there are cons!) of implementing Profit First, based on our real experience of helping businesses implement and manage Profit First over the years. Along with some tips and tricks for making it work for you.

In case you haven’t heard, Profit First is a technique for managing business expenses and cash flow popularized by the 2014 book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine by Michael Michalowicz.

So, is Profit First the secret sauce your business needs? Let’s dive in.

What is Profit First?

Profit First is an alternative to the traditional accounting formula of Sales – Expenses = Profit.

The Profit First formula is Sales – Profit = Expenses. Instead of considering profit to be anything left over after paying expenses, it calls for business owners to direct a percentage of all sales directly to profit before taking out expenses.

In simpler terms, it encourages you to prioritize profit, setting it aside before you pay your expenses. Think of it as the dietary advice of “eat your vegetables first” but for your business’s financial health.

The logic behind Profit First is that if a predetermined percentage of your revenue goes directly to profit each month, you’ll be forced to be conscious of your budget and figure out how to manage expenses rather than leaving profits to chance.

It’s basically the business version of “Pay yourself first” in action. By carving out a percentage for profit, a business should, well, have profit.

How the Profit First method works

Now that we’ve covered the Profit First system in theory, how does it work in real life?

Michalowicz recommends business owners set up multiple business checking accounts to distribute percentages of each deposit.

Those five bank accounts are:

  1. Income account. This is a general-purpose account where you deposit all business revenue.
  2. Profit account. This account holds a predetermined percentage of your revenue that you take off the top as profit.
  3. Owner’s pay account. This account holds the percentage of income used to pay yourself a salary.
  4. Tax account. This account holds the portion of business revenue allocated to pay taxes.
  5. Operational expenses (OpEx) account. This account holds the remaining business revenue after allocating funds for profit, owner’s pay, and taxes. The money in this account goes towards paying business expenses.

What percentage should you allocate to each account?

There’s no one-size-fits-all rule for how you allocate revenue to each bank account. However, Michalowicz shows some target allocation percentages (TAPs) based on your company’s annual revenues.

You don’t have to allocate each and every deposit to different bank accounts. Instead, the author recommends allocating revenue deposited into the income account twice per month on the 10th and 25th. However, you can change those dates based on what works best for your own business.

A Profit First example

To illustrate how the Profit First system works, say you own a photography business. Your annual revenue is $250,000 per year, and you follow the B target allocation percentages Michalowicz recommends.

From January 1st through January 10th, you deposit $10,000 in revenue into your income account. On the 10th, you would make the following transfers:

  • 10% to profit: $1,000
  • 35% to owners compensation: $3,500
  • 15% to tax: $1,500
  • 40% to operating expenses: $4,000

Once you make the transfers, your income account has a zero balance. Just make sure you pay your bills out of the appropriate accounts.

Pros and Cons of the Profit First system

Like any cash management system, the Profit First method has upsides and downsides. Here are a few to keep in mind as you consider whether Profit First is right for your business.

Pros of Profit First

  • Helps you stay on top of cash flow. Cash is the lifeblood of all small businesses. The time you spend managing your Profit First checking accounts keeps you dialed into your cash flow.
  • Encourages controlled spending. Taking your profit distribution before you spend money forces you to work with what’s left. This promotes smarter spending and cost-cutting.
  • Reduces fraud risk. Spreading your cash across multiple different accounts offers some protection from fraud because you don’t have all of your eggs in one basket.
  • Consistently profitable business: It ensures you always see some profit, which can boost morale.
  • Provides structure for your business finances: Many small business owners struggle to make sense of their numbers. The Profit First method simplifies how you handle your finances and helps give structure and a tangible quality to concepts that might otherwise feel abstract.

Cons of Profit First

  • Potential for underfunding. You might not allocate enough money to essential expenses, owners’ compensation, or taxes. This can lead to surprise tax bills, a strain on your personal finances, or needing more cash to cover operating expenses.
  • Not one-size-fits-all. This method might not suit every business model, especially those with fluctuating income or high overhead costs. Don’t feel like you have to mold your business to the book’s target allocation percentages—it’s ok to be flexible and make it work for your business.
  • Requires time and discipline. It demands a high level of financial discipline and taking time to regularly allocate funds to other accounts, which can be challenging to maintain.
  • Potential for high bank fees. Some banks charge monthly maintenance fees on business checking accounts. If you don’t set up your five accounts with the right bank, those fees can add up quickly.

Tips and Tricks for Implementing Profit First

Maybe you already have your mind made up and are ready to get started. Here are our favorite tips and tricks that we’ve seen work *wonders* with clients over the years!

Pick the right bank!

One of the biggest hurdles to implementing Profit First is the sheer number of bank accounts that you will need and the costs associated with them. If you’re leaning towards implementing Profit First, banking with Relay just might be a game changer. Why? Let’s break it down:

  1. Open multiple accounts with ease. Relay allows small businesses to open up to 20 checking accounts, which is plenty for allocating funds according to the Profit First method.
  2. No fees or minimum balances. Relay offers fee-free banking, which means more of your profit stays with you. Plus, you don’t have to maintain a minimum balance to qualify for fee-free checking — that’s great news since you’ll be regularly zeroing out your income account.
  3. Automated transfers. Relay allows you to automate transfers between accounts using dollar amounts or percentages, which can save a lot of time when following the Profit First method.
  4. Integration. Relay integrates seamlessly with several accounting software programs, including QuickBooks Online and Xero. This makes the process of tracking your cash flow and expenses a breeze.

Start Small

Not sure where to start? We suggest starting with two accounts – a profit account and a tax account – and making contributions to those two accounts. From there, you can build out more accounts and more structure. We recommend at least 15% to your tax account and something to your profit account to start (with the goal of bringing it up to a higher percentage). Something is better than nothing.

We believe that it’s better to build up the muscle of setting funds aside slowly than to jump right in and possibly derail your confidence.

Is Profit First right for your small business?

Implementing Profit First can be a great way to achieve instant profitability in your company, no matter how much revenue you bring in. It’s not a magic pill, but it’s a game-changer for many entrepreneurs. If you’re considering it, we recommend ensuring you have a good grasp on your numbers so you can decide on target allocation percentages that work for your business. We also recommend banking with Relay to streamline following the Profit First system and avoiding excessive bank fees.

Remember, every business is unique, and what works for one may not work for another. If you’re feeling a bit overwhelmed or just need a second opinion, please reach out. After all, when it comes to running a profitable business, two heads (or more) are often better than one! 

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