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Profit First Method: Transforming Business Banking for Success

Business BankingNovember 09, 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.

Profit First Method vs Traditional Method - Why should you choose profit first?Profit First Method vs Traditional Method - Why should you choose profit first?

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:

  • Income: This is your primary account. All revenue goes into this account first; from here, you distribute money to other accounts.

  • 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.

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

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

  • 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:

  • Set up the five Profit First accounts: Income (this is your primary account), 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.

  • 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.

  • Distribute your revenue: At least once a month, transfer money from your primary 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.

  • 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

Profit First is 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.

Is Profit First right for your business?

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.

How to set up Profit First with Found

Ready to take the leap into trying Profit First for your business? Here’s how to set up Profit First with Found.

1. Open an account with Found for free.

If you don’t already have a Found account, now’s a great time to open one. You can create a Found account in minutes, and it doesn’t require an appointment at an in-person branch. Creating a Found account doesn’t impact your credit score, but generally, you’ll need to provide your legal name, address, social security number, and date of birth. 

2. Create your Profit First pockets.

When you create your Found account, we’ll automatically create a Primary and Tax pocket for you. All your income is deposited into your Primary pocket. You’ll need to create pockets for the three remaining Profit First buckets: Profit, Owner’s Pay, and Operating expenses. When you’re creating your new pockets, you can select a color and icon for your pocket, and you’ll see those choices reflected on your Banking tab.

3. Determine your Profit First percentages

After you’ve created your Profit First pockets, it’s time to determine what percentage of revenue should be allocated for each Profit First pocket. The Profit First model makes it easy and provides suggested Target Allocation Percentages (TAPs) based on your real revenue range. Check out the chart above if you need a starting point.

What’s the difference between “total income” and “real revenue”? Total income is the top-line revenue of a business and represents all cumulative sales. Real revenue is the total income minus the cost of materials and subcontractors. For example, a home builder may have $15M in annual revenue and require $8M worth of materials and subcontractors to complete their projects. The business’s real revenue is $7M, not $15M and they should use that real revenue range when determining the TAPs.

4. Set up deposit allocation percentages

The Profit First model recommends manually transferring money twice per month (on the 10th and 25th) to the appropriate buckets. With Found, it's easy to transfer money across your Profit First pockets; or you can also set up deposit allocation percentages based on your TAPs to make this process even more convenient. Each time you get paid, the correct percentages of money will move to your Profit First pockets based on your deposit allocations. You can see the distribution in your activity details. 

Automatic deposit allocations are a great way to get in the habit of using this new financial model. If you prefer to move your money the old-fashioned way while you get the hand of Profit First, you don’t have to set up deposit allocation percentages. 

5. Pay expenses from your pockets

When it comes time to pay your expenses, be sure you’re paying from the appropriate pocket. While using your physical Found card will always pull funds from your Primary pocket, you can also create additional virtual cards and attach them to your corresponding pocket. When you use a virtual card to make a purchase, it uses the funds from the pocket it’s attached to. 

For example, you can create a virtual card for operating expenses, and attach it to your Operating Expenses pocket. When it comes time to pay your freelancers or purchase new business equipment, you can use your virtual card and it will automatically deduct the funds from your Tax pocket. One less thing for you to worry about!

6. Distribute your profits quarterly. 

The Profit First model recommends business owners take 50% of their profit each quarter as a distribution–this money is for the business owner, not for the business. You can invest the remaining 50% of your profit in the business, put it in an emergency fund, or save for a larger goal.

In addition to profit distribution, you’ll also want to make sure to pay your quarterly tax payments so you aren’t hit with hefty fines or penalties.

Profit First with Found

Ready to take control of your business finances and make profitability a priority? Found can help. With our tools and our new pockets feature, it’s easier than ever to implement Profit First for 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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