Running a business is no simple feat. It takes dedication, discipline, and at the very least, a basic understanding of finance and accounting principles. While your dedication and discipline may come naturally with your entrepreneurial spirit, most business owners find mastering the financial side of the business a struggle. This is where the Profit First method aims to help.
This concept of putting profit first is quickly gaining traction among business owners, particularly those who own law firms. The Profit First equation (Sales – Profit = Expenses) is a simple switch that people can use to calculate and boost their profitability. Unlike the traditional formula, this method challenges you to prioritize your profit instead of just taking what’s left over after calculating your sales and expenses.
The Story Behind Profit First
Profit First accounting was first developed by Mike Michalowicz, an entrepreneur who needed a better way to build a profitable business. After speaking to the impact of the Profit First method at events, Michalowicz found there was a deep need for this ‘accounting hack’ to reach more audiences.
In his book, “Profit First,” Michalowicz turns the traditional accounting formula on its head, diving deep into the psychology and benefits of putting profit first.
Why Profit First
It’s easy to let the costs of running a business double up. And, if you don’t actively prioritize your profit and try to keep your expenses at bay, you might be left with a business that isn’t making money. The Profit First method brings a new approach that could enlighten what might be holding your business back and ultimately, help you better prioritize your profit.
The traditional accounting formula, Sales – Expenses = Profit, may be the most intuitive way to account for your business’ profitability. But, if you’re running on survival mode, consistently revisiting your business’ profitability and failing to see results, it may be time to try something new—like Profit First accounting.
Profit First accounting encourages you to see your expenses as variable, and your profit, concrete. Instead of calculating your sales and expenses with the hope that you’ll have something leftover, the Profit First method aims to ensure you don’t go another year running a business without anything to show for it.
How to Implement Profit First
Implementing the Profit First method is as simple as switching a few numbers around. The challenge is making sure you have the right mindset and the right spending habits to make it work.
Create Multiple Accounts
Profit First is all about spending smarter and spending less. By allocating your cash reserves to different accounts, you can easily separate what you need to save and what you can spend.
When it comes to creating these accounts, Michalowicz recommends setting them up based on the core areas of your business.
Your different accounts:
- Profit — savings account
- Tax — savings account
- Owner’s pay — savings account
- Operating expenses — checking account
- Revenue — checking account
While your profit, owner’s pay, and tax are put into the bucket of a savings account, your revenue and operating expenses are better allocated into checking accounts. Depending on your business and goals, you might build out more accounts and get even more granular with the system as time goes on.
Evaluate Your TAPs
This is where things get a little more technical. Your Target Allocation Percentages (TAPs) tells you how much money you want to allocate to each account based on your revenue. For a visual of what this looks like, check out this table from Michalowicz’s book. You can see what percent of your revenue you should allocate to your tax vs. owner’s pay based on how much revenue your business is making.
Your TAPs shows you where you want your revenue to go once your business is running with profitability, not necessarily where your business can allocate comfortably now. If you’re operating at a loss, it might be easy to doubt that you can allocate cash to any account. Don’t fret—just start small and use your data to better understand what percentages you’re comfortable with.
It’s important to establish a cadence for transferring your revenue into your different accounts. In his book, Michalowicz recommends a 10/25 rhythm. This means transferring funds twice per month, on the 10th and 25th day of the month. While this framework might work for you, it is not the only rhythm to follow for consistency. Consistency is key, however, so do choose a cadence that works for you and stick with it.
Review & Make Changes
At the end of every quarter, you should evaluate your Profit First system and see where you can make changes. As your business grows or shifts, you will need to edit your accounts and change how much you allocate to each of your accounts to reflect that growth or shift.
Profit First for Lawyers
Lawyers didn’t go to law school to learn how do their accounting. But, just like with any business, it’s important to understand the basic principles and find ways to boost your profitability.
Learning and implementing the Profit First formula could help you better manage your cash flow and reduce your overall spend. By the traditional accounting formula, Profit First accounting aims to help you focus on what’s important to the health and growth of your firm.
Profit First in Review
Reversing the traditional accounting equation, the Profit First formula challenges business owners to re-think their cash flow and give profitability more attention. While this concept is worth investigating, implementing this strategy will take some heavy lifting.
If you’re going to implement the Profit First method, you need to have time and a strong grasp on your finances. Profit First requires the daily management of your accounts and TAPs, and a steadfast dedication to keeping your spend down. Most likely, these are areas not covered by your accounting solution.
If you’re hard-pressed for time, but you need to better manage your accounting, consider ScaleFactor. Providing automated accounting solutions, ScaleFactor can give you what you need to drive better business decisions without going through the hassle of creating multiple bank accounts.
Director of Sales