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Profit First Method: Transforming Business Banking for Success

Business BankingJune 22, 2023

Managing finances can be a real headache, especially when your income isn't consistent. One month you're riding high, and the next, you're scraping by. It's a rollercoaster that can leave you feeling out of control. But what if there was a better way? Enter Profit First.

It sounds simple, but many business owners often lose sight of the fact that the goal is profit rather than growth. Learning how to set goals for your small business is a great way to stay on track toward both. With the Profit First approach, you'll be better equipped to make impactful decisions for your long-term vision.

What is Profit First?

Profit First is an innovative approach to business finances that flips the traditional accounting formula on its head. Instead of Sales - Expenses = Profit, Profit First argues for Sales - Profit = Expenses.

In other words, you take your profit first, and then the remaining amount is what you have to cover your expenses. To do this, you set up five specific bank accounts for each category where your revenue needs to be distributed and allocate percentages of each dollar of revenue into these accounts. It's a simple shift in thinking, but it can profoundly impact your business.

The man behind this idea is Mike Michalowicz. After experiencing the highs and lows of entrepreneurial life, Michalowicz decided there had to be a better way to manage business finances. His solution was Profit First, a method he introduced in his book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine.

Why is Profit First effective?

There are lots of reasons why businesses fail. But in the end, they all come down to a lack of profitability. Profit First is effective because it changes how you think about your business finances. Instead of seeing profit as what's left over after expenses, you see it as a priority. This mindset shift can help you make better financial decisions, reduce unnecessary expenses, and ultimately increase your profitability. 

What are the 5 Profit First accounts?

The Profit First method involves utilizing five separate bank accounts:

  1. Income: All revenue goes into this account first; from here, you distribute money to other accounts.

  2. Profit: This account is for your business's profit. Money in this account is a reward for the business owners and can be distributed quarterly.

  3. Owner's Pay: This account is for the owner's salary or wages.

  4. Taxes: Money in this account covers your business's tax obligations.

  5. Operating Expenses: This account covers all the costs of running your business.

If you have a small business, learn more about online vs. traditional banking to help you decide which type of bank account is best for you.

How does Profit First work?

When you receive income, you distribute it into five different accounts. Each account has a specific purpose and percentage allocation based on your revenue. This system ensures that you always have money set aside for profit, your pay, and taxes. If you're a freelancer, there are a lot of benefits of setting up a business bank account.

The magic of Profit First lies in its ability to change your financial behavior. By prioritizing profit, you're forced to work with what remains for expenses. This can lead to more mindful spending, helping you cut unnecessary costs and focus on what truly drives your business's growth. And with regular profit distributions, you get to enjoy the fruits of your labor, boosting your motivation and commitment to your business.

How to set up Profit First:

  1. Set up the five Profit First accounts: Income, profit, owner's pay, taxes, and operating expenses. For simplicity’s sake, you’ll want these accounts at the same bank so it’s easy to distribute funds. Also, consider how much it will cost to maintain the separate accounts. Find low or no-fee business accounts if that’s a concern.

  2. Determine your Target Allocation Percentages (TAPs): Start with how much profit you want to set aside. What makes sense for your industry and your business? For example, let’s say you want 5% of your revenue to go to your profit account. Then, you might allocate 50% to the owner’s compensation account, 30% to operating expenses, and 15% to the tax account. Need help figuring out your TAPs? See the Profit First TAPs chart below.

  3. Distribute your revenue: At least once a month, transfer money from the income account into the other various accounts. The percentages make it easy to determine how much money should move into each one, whether you’ve got $1,000 or $1,000,000.

  4. Use the accounts for their corresponding purposes: Pay your bills with money from the right account. For example, pay your quarterly estimated taxes from the tax account.

Profit First TAPs chart for business banking Target Allocation Percentages from Mike Michalowicz Profit First Method

Source: TAPs by Mike Michalowicz

It's a simple and easy-to-understand system. It encourages financial discipline and can help businesses become more profitable. On the downside, it may not suit all businesses, particularly those with high overheads or tight margins. It also requires a shift in thinking about allocations, which some business owners may find challenging. But for many, the benefits far outweigh the drawbacks.

How to determine whether Profit First is right for you

Every business owner wants profit, and the Profit First method might sound like a way to create it magically. However, before totally revamping your business's financial setup, consider whether the Profit First method will fit your particular needs.

Pros of Profit First Method:

  • Provides financial control: Profit First empowers business owners to take control of their finances and ensure profitability.

  • Creates structure: Those struggling with irregular income and keeping expenses in check can benefit from this method.

  • Applies to various businesses: From freelancers to startup founders and small business owners, Profit First can aid in more effective financial management.

  • Useful for successful businesses: Even thriving businesses can benefit from the clarity and discipline that Profit First brings, helping to ensure sustainable growth.

  • Aids in stress management: If you're consistently struggling to make a profit, manage your expenses, or stressing about money, Profit First can be a game-changer.

Cons of Profit First Method:

  • Not a one-size-fits-all solution: Profit First might only suit some business types or situations. Understanding the basics of small business banking is essential, especially for newer or less organized businesses.

  • Discipline is required: The method requires a willingness to make potentially tough decisions about expenses and a commitment to a new way of managing business finances.

  • Initial effort required: Determining whether Profit First is the right fit involves introspection and a clear understanding of your business's financial health, which might be challenging at some stages of a business’s development.

  • Doesn’t replace generating sufficient revenue: Sometimes, the quest for profit is about drumming up more income. Regardless of your industry, look for ways to grow your business.

Profit First with Found

Ready to take control of your business finances and make profitability a priority? Found can help. With our tools, you can easily track your expenses, find write-offs, and save receipts, making the Profit First method even simpler to implement. Don't wait to transform your business. Sign up for Found for free and start your journey toward permanent profitability today.

This material has been prepared for informational purposes only.

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