Should I be using the Profit First method?
The 'Profit First' methodology, based on a book authored by Mike Michalowicz, has become somewhat of a 'Bible' on accounting for SMEs. You may wonder what the buzz is all about and if you should consider looking into this methodology for your own business. We've written an overview of the publication's principles so you can decide for yourself!
Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine by American author Mike Michalowicz first hit the scene in 2014. However, the concept has been trending in our conversations with business owners more and more frequently. Word on the street is that over 175,000 companies have implemented the system. So, yeah. We think he might be onto something!
The short version:
The overarching concept of the book is to reframe the way that business owners think about their cashflow: every time you get a deposit from sales, take a predetermined percentage of that money as profit.
The [not that much] longer version:
The common method of accounting, as we all know it is:
Sales - Expenses = Profit.
Michalowicz’s methodology reverses this equation. The result:
Sales - Profit = Expenses.
This principle is key to helping you sustain cash flow in your profitable business, and it all starts first with creating multiple bank accounts. Multiple bank accounts... anyone else getting Barefoot Investor flashbacks right about now?
Here's are a few ways we can help you go Profit First at Thriday.
1. Setup multiple bank accounts
Creating multiple bank accounts allows you to set up automatic processes to allocate funds for each financial function of your business. It also means that you will not overspend in areas that could easily occur with one bank account.
With Thriday, you will be able to setup up to 9 bank accounts for your business. You can customise them by naming the separate accounts. Based on the Profit First method, you would setup 5 accounts that look like this:
- Income — used for deposit of income only
- Profit account — to accumulate profit
- Owner's Pay — payment of your wage
- Tax — used for payment of taxes
- Opex — used for payment of day-to-day running expenses
To do: Determine your allocation percentages:
Your Current Allocation Percentages (CAP) are based on what you are currently spending in each of these foundational areas (Profit, Owners Compensation, Tax, and Operating Expenses). These percentages are based on your revenue.
Then, compare your numbers with the target allocation percentages for a similar ‘healthy’ business with your revenue levels. Here's a good guide to start with.
The Thriday product will allow you to setup payments between your accounts. It will only take a few minutes to setup, but automating between your accounts will save you headspace in the long-run. Tip: A semi-monthly rhythm is ideal as it enables a fortnightly allocation percentage schedule where you can pay all bills from your Operating account once allocations are made.
To do: The profit first methodology suggest that you calculate your revenue for the period in the Income account. Then transfer to the Profit, Owner's Pay, Tax, and Operating accounts. These amounts are based on your CAPs.
Using the Profit First methodology, as you generate a profit, you are going to want to remove the balance from view: "out of sight, out of mind". When you have a Thriday account, you can control how your home screen looks:
- Set your 'Income' account to display first. If you're anything like us, you like to see exactly what is coming in and when it comes in.
- Set your 'Profit' account to display last. A few thumb-scrolls away will stop the temptation to dip into the account.
Sound interesting to you? If you think going Profit First is the way to go for your business, we want to support you.