Are You Taking Your Profit First?
In a prior blog I shared how I used the Profit First methodology to turn my business from a cash eating machine to financially healthy. I went from having sporadic cash flow to having enough cash to:
Receive a regular paycheck from my business (even in slow months)
Have money set aside to pay my income taxes
Pay off my SBA loan early
Take a regular quarterly profit distribution as a reward for running a financially healthy company
Build up operating reserves, i.e., emergency fund. As of this writing I have 4 months of operating expenses in the bank in case the world turns upside down again (Coronavirus, recession anyone?)
Was it simple? Yes. Was it easy? No. But it was totally worth it, and it all began with one easy step.
Taking my profit first.
Why is it important to focus on PROFIT? Because as humans, we are programmed to place significance on what we see first. It’s called the Primacy Effect.
Traditional accounting has taught us that Sales – Expenses = Profit. That’s fine and dandy for financial statements but not for business owners who live in the real world.
When we follow the traditional formula, we are primed to focus on two words, Sales and Expenses and we treat Profit as an afterthought. This puts you into a cycle of selling to pay bills, repeatedly, all while wondering why you never see any profit.
However, something magical happens when you flip the formula to focus on profit. When you change the formula to Sales – Profit = Expenses your focus changes to taking your profit first!
Taking your profit first forces you to eliminate unnecessary expenses from your operating costs.
As you read this, you might be thinking to yourself, “My company has never had a profit. And if it shows a profit on paper, I certainly don’t have the cash in the bank for a profit distribution!”
Neither did I and that is why taking your profit first needs to happen today, right now. Remember the primacy effect? If you focus on profit, it will happen.
Here are the steps to taking your profit first:
Open a business checking account in addition to your operating account – you want to keep your profit account separate from your operating account. Call this new bank account your Profit Account.
Start with 1%. That’s right, out of every dollar in revenue that comes into your business, take 1% of that and move it to your Profit account. I promise you won’t miss 1%.
Get into a rhythm. You can do this daily, weekly, bi-weekly, etc. The important thing is to set up a rhythm so you can enforce the habit. Move money to your account before you pay bills, order inventory or run payroll.
Once you are into a good rhythm, consider upping your profit allocation to 2%.
Gradually adjust your profit allocation up 1% to 2% every quarter and keep your routine consistent.
You’ve come to the end of your quarter and now the fun begins! What are you going to do with the money in your profit account?
You have several options. If you have business debt, you could make an extra principal payment. Do you want to have a six month emergency fund? If so, you could open another account and move the money there.
Some business owners I work with take half as a profit distribution and move half to a rainy day account. Regardless of what you do, make sure you distribute some profit to yourself as a reward for running a profitable business. It might be something as small as taking the family out for ice cream or hamburgers. Celebrate your PROFIT win!
Whether you’re a business owner or are starting your own venture, using a Profit First strategy can help ensure that profit is always at the forefront of your business planning.
Stay tuned for the Part 2 of this Profit First series where we will discuss owner compensation. After all, you are your company’s most valuable employee. Shouldn’t you get paid?
