Don’t get caught up in the trap of believing that you’ll see results from your business if you just work harder and longer. In “Profit First,” entrepreneur Mike Michalowicz explains how to assess the financial health of your business and start managing it better. In this book review, you’ll learn the simple steps you can take to start making a profit today.
Learn how to make your business profitable from day one.
READ THIS BOOK REVIEW IF YOU:
- Want more financial freedom in your personal life
- Never have enough money left over to pay yourself a salary
- Work long and hard at your business without seeing a profit
A failure to generate profits is one of the main reasons businesses fail. If you’re putting in the work and still not seeing results, you might start to wonder if you’re the problem. The good news is that, in most cases, you’re not; instead, the issue often lies with the system you’re using.
If the old profit formula “Sales – Expenses = Profit” isn’t working for you, there’s a simple solution: Take your profit first. This sounds strange and requires you to change your business mindset, but it’ll stop you from doing things that aren’t working and start making your business profitable from day one. Eventually, you’ll find that the Profit First system is easy to use because it works with how you’re naturally wired. These steps will get you on the path to creating a profitable business:
- Make use of instant assessment. Use this tool to understand the financial health of your business.
- Set up different bank accounts. Create separate checking accounts for income, profit, taxes, owner’s compensation, and operations expenses.
- Create “hold” accounts. Set up tax hold and profit hold accounts at a second bank, so they aren’t convenient to access.
- Set allocation percentages. Determine what percentage of income should go into each account now and what percentage should go toward targets for the future.
- Put the Profit First system into action. You won’t see any results until you start using it.
- Use Profit First to get out of debt. Use the system to pay down your debts and set yourself up for a healthier financial future.
- Focus on efficiency. Make your business more effective by reducing your offering and cutting out bad clients.
- Live a Profit First lifestyle. Apply the system to your personal life to create financial freedom.
Your Business Is an Out-of-Control Cash-Eating Monster
Like Dr. Frankenstein, you may have dreamed up your business and brought it to life — only to have it turn into a monster. If your business has become a monster, you’ll find it eating up all your cash and time, and before you know it, you may feel like the monster has taken control. If this is true of your business, it’s time to take back that control.
Cash is king, and there’s a big difference between making income and making a profit. It doesn’t matter how talented you are or how strong your work ethic is; your business is likely to fail if you don’t get serious about financial security.
While it can be painful to realize that your business isn’t as healthy as you thought, it’s better to acknowledge that reality than to live in denial about it. If you continue pretending that nothing is wrong and telling yourself that it’ll sort itself out, you’re only setting yourself up for disappointment. Even if you’re able to pull off spectacular growth, your company will still suffer if you don’t have your financial health in check. When sales slow, you won’t be able to cover expenses, and when sales speed up, you risk being lulled into a false sense of success that may not be sustainable.
Greater revenue doesn’t make you more successful or help you turn bigger profits — you’ll need to get out of the “grow, grow, grow” mindset. While growth is important, there needs to be balance. You don’t want your business to turn into the guy at the gym who has massive arms and toothpick legs because he only exercises half of his body. Using growth as a justification for avoiding your problems will only create a bigger monster.
Most people hope that if they grow their business big enough, they’ll make a profit; this isn’t necessarily the case. You need to start thinking of profit as a habit that happens every time you make a sale. Once you start concentrating on profit, you’ll discover more efficient ways to grow and streamline your business. Efficiency is needed for profitability.
When it comes to accounting, most businesses subtract expenses and taxes from their sales, which is why there’s so much focus on growing the top-line revenue. This creates the false idea that generating more sales will lead to a bigger profit. In reality, this system goes against the human nature of spending: If you have more money, you’ll find a way to spend more money. That’s why there never seems to be enough left. You get so caught up in reinvesting in your business that salary and profit become afterthoughts.
The Profit First system works within the realm of human nature and makes things simple by showing exactly how much money you have in the bank and identifying problem areas early. It also gives you a clear outline of where you stand regarding money saved for taxes, compensation, business operations, and profitability.
The Core Principles of Profit First
The Profit First system works because it doesn’t require you to change your habits; rather, it leverages the habits you already have. One of the best pieces of weightloss advice is to eat from smaller plates, and the same idea can be applied to money. If you have a lot of money available, you’re likely to eat it up quickly. But if you split the money up into smaller “plates,” you’ll spend that money differently, as you have a smaller amount to work with. In other words, with less cash available, you’ll find a way to work with what you have.
Do you ever feel like the things you do expand to fill the time you have available? Whether your deadline is a week from now or tomorrow, you’ll use the whole time to get the task done. This is the same idea behind clearing your plate, no matter how big it is. In economics, the idea that demand expands to match supply is called Parkinson’s law. According to this “law,” you’ll find a way to spend the money you have. On the flipside, you’ll find ways to operate with whatever you have available. By taking your profit first, you’ll have less to work with, but you’ll also be forced to find innovative ways to get the same results — or better — using less. This will save you money and drive your business forward.
Another core principle is the primacy effect principle, which is based on the idea that you assign more significance to whatever comes your way first. If you serve vegetables first, they’ll likely take up a bigger portion of your plate than they would if you served them last. In the traditional business financial formula, sales come first. This is why many people get stuck in the cycle of only focusing on the bottom line and not prioritizing profit. However, if profit comes first, it becomes your main focus, and it will always exist. By reverse-engineering profitability and taking profit first, you’ll know exactly how much you have left for expenses. If you can’t pay your bills after doing this, there are some major issues that need to be resolved. Taking a closer look at what’s making and costing you money helps you streamline processes and dump unnecessary resource drains.
Once you take your profit, put it out of sight to remove the temptation to steal it from yourself. Think of enjoying a delicious slice of cake: You’re going to want to hide the rest of the cake out of sight, so you don’t eat it all and can enjoy some later.
Lastly, start small to set yourself up for long-term profitability. Don’t get carried away slicing off a chunk that’s too big too soon — you don’t want to be forced to backtrack if it proves to be unsustainable. Taking small steps can help you win over your mind and build trust in the Profit First system.
Setting Up Profit First & Assessing the Health of Your Business
Status updates from your accountant are great, but do you really understand what the documents say? Simply checking out what’s in your bank account is an easier, more natural approach to understanding how much money you have to work with. However, it’s easy to get caught in the trap of believing there isn’t enough in your account to pay out a profit. This is why you need to take the profit first. The Profit First system works with bank balance accounting, but it uses multiple bank accounts to make sure your money is appropriately earmarked.
Setting up different bank accounts is like having small plates to eat from. To put the Profit First system into action, you should immediately set up five checking accounts: one for income, profit, owner’s compensation, tax, and operating expenses. Create two additional “no-temptation” hold accounts at a different bank for taxes and profit. These will keep that money out of sight so that you don’t touch it before you’re meant to. If your profit is too easily accessible, you might be tempted to use it to cover expenses rather than make the necessary changes to fit into the available budget.
It’s important to move money from the income account first to the profit and tax accounts at your primary bank before moving it to the profit hold and tax hold accounts at the second bank. This ensures you have a full view of how your finances are distributed, even if the transfer to the second bank takes a few days.
You can’t improve your business’ financial health if you don’t get real about it. It might be painful at first, but it’ll be worth it in the end. The sooner you fix any problems you may have, the better. Profit First doesn’t simply make your business profitable; it can also show you how to improve its health and operate more efficiently, which will likely result in better growth and sales.
Completing an assessment of business health may not be fun, but it’ll help you get things on track. Since Profit First is a cash management system, your focus will be on money coming in and out of your business. It’s that simple. Completing the instant assessment provided in the book will help you identify the target percentages you should be working toward. The instant assessment will also bring clarity to where you need to make adjustments in your business and highlight the areas that need work, empowering you to fix them. It’s all about making your business better.
Allocation percentages determine how much you’ll transfer from your income account to your profit, owner’s compensation, and tax accounts. As mentioned, the instant assessment will give you an idea of where you should start but don’t get bogged down trying to perfect the percentages. Analysis paralysis is an easy trap to fall into, but it’s better to get started with a good estimate than waste your time striving for a precise figure.
Another common issue is setting the percentages too high too quickly. Aiming for a 20% profit right out of the gate sounds great, but is it sustainable? If you tried to donate 20 gallons of blood in one go, you’d die. Taking too much from your business will have the same effect. Your target allocations percentages (TAPs) are what you want to reach over time, not what you should start with.
Your current allocation percentage (CAP) is your starting point; it’s where your business stands right now. Over time, this number will be adapted to bring you closer to your TAPs. The key to finding success with the Profit First system is bringing the small steps together to inch closer toward your goal. Even if you never reach the TAPs you set, they’ll keep pushing your business to innovate and improve in an effort to get closer. While it’s important to start small, the ability to grow your profit allocation percentage over time will mean that you must run your business efficiently and spend less.
As a business owner, your business is there to serve you — not the other way around — so make sure you’re getting a paycheck. This is what the owner’s compensation allocation percentage is for. This should reflect an acceptable salary for the type of work you’re doing within the business. If you can’t afford to pay yourself a respectable salary, the hard truth is that your business isn’t healthy.
The tax allocation percentage should cover the company’s tax payments and your own tax liabilities if you’re the owner. Allocating enough for taxes will save you headaches when tax season comes around. Once you’ve moved the allocated percentages to the profit, owner’s compensation, and tax accounts, you’ll be left with your operating expense allocation. This is the amount that you have to cover your expenses.
Putting Profit First into Motion
Most entrepreneurs start their business with the goal of improving their lives. But this can’t happen if you let your business run you. Your business should primarily serve you, and the Profit First system will help it do that.
Start by telling your accountant about your plan to implement Profit First, so they can get on board and assist you. Then, set up your accounts and name them appropriately, making sure to include the CAPs and TAPs you determined using the instant assessment so that they’re clearly in sight. It’s best to start small and reevaluate quarterly.
While setting up this system is a step in the right direction, nothing will happen until you start taking action. You’ll have a profitable company from the moment you make your first distributions, so you should start immediately. The profit will seem small at the beginning, but starting with a small percentage should motivate you to reduce expenses and increase your profit allocation percentage in the future. Once you’ve taken these first steps, take time to celebrate — you’re now on the road to a healthy, profitable business!
You should also take a profit check every quarter. This is your reward for owning the business. Each quarter, take 50% of what’s in the profit hold account and leave the other half to accumulate. A note about the profit check: It should never go back into the business. If you must reinvest this money in your business, your business isn’t running efficiently enough. The profit money is strictly for you to enjoy.
The Profit First system can also be applied to your personal life. Using this system to manage your personal finances can help you save for something fun, create an emergency fund for a rainy day, or wipe out debt. Learning to reduce expenses and save money will secure you financial freedom and let you enjoy more of what life has to offer.
The ideas behind the Profit First system are so simple that you can even teach them to your children and set them up for a healthy financial future. Rather than giving them an allowance, assign a value to different chores and let them decide how much they want to make. When they start earning money, give them envelopes to allocate their earnings for different purposes. This will teach them the value of money, how to earn it, and how to manage it.
How to Keep It from Falling Apart
There are a few common mistakes that people make when putting the system into use. One of them is trying to do it alone. Using an accountability buddy is a great way to make sure you don’t fall off the wagon.
Trying to do too much too soon is another common mistake. Having to reduce your allocation percentages because you initially set them too high defeats the purpose of the system. Additionally, getting caught up in the idea that growth must come before profit is another pitfall. Profit should come first, and it will help you grow.
Sometimes, creating more efficiency requires investment. But taking money from an account you shouldn’t and reinvesting it back into the business is a bad idea. Again, if you don’t have enough money to cover expenses in your operating expenses account, there’s something that needs to be fixed. If you steal from your tax account, you’ll be in big trouble when tax season rolls around.
Lastly, not setting up the separate recommended bank accounts is a major pitfall. It’s a key part of the system, so if you aren’t doing it, you aren’t implementing the system properly, and it won’t work.
Don’t overcomplicate things, and you’ll see results!
Profit First is a simple system that can change the financial health of your business. If you’re looking for something that will naturally and immediately give you real insight into your current situation, Profit First is the system for you.
Using this technique, you can learn how to improve your business and start making you a profit today. All you have to do is be willing to put in the work to implement it.
About the author
Mike Michalowicz is the author of three books and co-founder of Profit First Professionals, a membership organization that teaches the Profit First method. He has launched two multi-million dollar companies, and his writing has appeared in publications such as The Wall Street Journal, Entrepreneur, and Harvard Business Review.