How to Put Profits First

…and totally change your business.

Every once in a while you come across an idea in business that makes so much sense you think to yourself — How could I have been so silly? This is obvious, it was there in front of me all along, and had I done that, my life would be very different. That’s what happened to me when I heard about and understood Profit First.

The name comes from the title of the book Profit First by Mike Michalowicz. Mike sounds like a humble guy who had a bunch of early success, fell into the arrogance trap, found bankruptcy, and then found humility. I know the trip — I did it, too.

I’ve heard him tell the story of announcing to his family they were out of money and his nine-year-old daughter could no longer take horseback riding lessons, at which point she ran out of the room and returned quickly with her piggy bank announcing that it was okay. If Daddy couldn’t buy things, she could, and handed him her piggy bank.

You see, that’s how you find humility. My story was similar. Bankruptcy sucks, and it teaches you a ton if you pay attention.

Mike developed this system called Profit First. For all the details, get the book here. It applies to all small and independent business owners. In the book, Mike turns the basic accounting equation used in all business on its head. Instead of…

Sales — Expenses = Profit

which is the standard way of accounting and thinking about your business, Mike uses this equation:

Sales — Profit = Expenses

Do you see the switch between profit and expenses? Mike’s formula is to take a percentage of ALL sales revenue and put it away as profit BEFORE anything is spent on expenses. That way, your business will always be cash basis profitable. Oh my, how I wish I had done this!

Mike has a lot of information about why this works, and you should read it in his book. For my part, I just set it up myself for my businesses — the writing business, the coaching business, and the AirBNB business.

The mechanics are quite simple and pretty much the same across the board. First, you decide what your profit percentage is going to be. Start low… like 3% or something. Or even 1% if you are not sure. But start.

Once you have your number, open a separate savings account and name it your profit account. Twice a month, on the 1st and 15th, look at your revenue for the preceding 15 days, calculate the percentage, and transfer it to your profit account. That way, it is not on the books. Out of sight, out of mind.

Then, once a quarter, take it one step further and empty the profit account by putting the money into a separate account in a different financial institution. More out of sight, more out of mind.

The starter system recommends other accounts as well — your owner compensation account (which is the money you need to live on), the expense account (which is what you pay the business bills from), and the taxes account (which is where you store cash for paying taxes when they are due).

So, to be more detailed and accurate, the new equation is this:

Revenue — profit — owner comp — taxes = expenses

The advantage is clear: Because you have put aside money for the things you are going to need, you have to manage the business from what is left, and what is left in the expense account is less than it looked like. That has a way of sharpening the mind.

Had I managed my business financials this way, my life would be very different today. Instead, as a friend of my daughter’s said to her one time: “Your family lives from paycheck to paycheck… it’s just that they are very large paychecks!” I desperately took us into and out of lines of credit as I navigated extreme expenses both in and out of the business. There was never a real plan — we just had to keep doing whatever was necessary. As I proudly told people, “I’m the king of cash flow.” I could always get the money to work… until I couldn’t.

This simple formula is critical for entrepreneurs because of all the things that make entrepreneurs, artists, farmers, and other independent people fail, financial mismanagement is number one. Why is that? Because in business, as my old mentor Ernesto Sirolli told me one time, there are only three kinds of people in the world — those who love their product or service, those who love to make a deal, and those who love to count money. The counters rarely start businesses. Almost all entrepreneurs are either in love with the product or they just love to sell and make deals. As a result, they are always thinking all they need is more sales when the real need is for more financial control and management. Profit First gives them that in a simple-to-implement way.

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