I talk about Profit First a lot with my clients, on my podcast, and on Instagram. So, what is Profit First, and why should it matter to you as a small business owner? Let’s dig in with some basics right here in this post.
What is Profit First?
Profit First is a book by Mike Michalowicz, and a system.
Profit First Professionals is the organization built to support the teachings in the book (and I am an accredited Profit First Professional).
The Profit First system is a “pay yourself first” cash flow system, not an accounting system.
Here’s the good news: you don’t need to understand accounting to understand cash flow and your business finances.
As a matter of fact, the GAAP formula(Generally Accepted Accounting Principles) for determining a business’s profit is not helpful in actually helping business owner’s prosper.
Often times, you will get to the end of the year and your accountant will tell you that you have profit but you don’t actually have the cash in hand.
That’s where Profit First comes in and makes sure you actually get the profit in your hands.
The GAAP (Generally Accepted Accounting Principles) formula for determining a business’s profit is: Sales – Expenses = Profit.
It is simple, and while logically accurate, does not account for human behavior.
In the GAAP formula profit is a leftover, a final consideration, something that is hopefully a nice surprise at the end of the year.
However, as we know from hard experience, the profit is rarely there, and the business continues on its check to check survival.
With the Profit First formula, you flip the equation to
Sales – Profit = Expenses.
Logically, the math is the same, but from the standpoint of the entrepreneur’s behavior, it is radically different.
The Profit First equation is sales -profit =expenses
NOT sales – expenses = profit.
With Profit First, you take a predetermined percentage of profit from every sale first, and only the remainder is available for expenses.
How Profit First Works
Here’s why Profit First works for optimising human behaviour:
Author and historian C. Northcote Parkinson theorized that our demand for a resource increases to meet the supply of it.
Hence why, when we are given two weeks to do a project it takes exactly two weeks, and when we are given eight weeks to do the same project it takes eight weeks.
This is called Parkinson’s Law.
Profit First makes Parkinson’s Law an asset.
By taking profit first, you prioritize your financial health and deprioritize spending money on expenses.
You are forced to find creative ways to do the same things for less or make better use of what you have. You will start to make sure every dollar is being used for continued growth or to enhance your personal freedom.
As Ron Saharyan, the Co-Founder of Profit First, explains in my interview with him on the Bold Money Revolution Podcast:
“We’ve all been told all our lives that we need to pay ourselves first, but no one teaches us how to do that.
And that’s what Profit First is.
So, every business owner out there understands that we need to have systems: marketing systems, hiring systems, service delivery systems, on-boarding systems.
Yet, if you go to a coach, you to an accountant, you go to a bookkeeper and you ask them, “What is the cash flow system that I should be implementing to ensure that I’m paying myself?”
They’re going to look at you and say, “Well, it’s simple, you sell, sell, sell, occur expenses, manage your expenses, and whatever you have leftover is the profit, and that’s what you pay yourself with.”
The traditional business cash flow system is backwards.
To enable your business to become a wealth-generating machine, we need to think about profit and revenue differently.
Here’s Ron again:
“With profit, you can hire. With profit, you can pay down debt. With profit, you can be philanthropic. And so by putting profit last, from a behavioral standpoint we’re saying it’s an undesirable, it’s the leftover, it’s the crumbs. And so Profit First flips the equation”.
6 figures in revenue does not equal 6 figures in salary.
This was my biggest “a-ha” moment in my business when I started:
This is often a point of confusion for business owners. It certainly was for me when I started.
When I wanted to replace my six-figure corporate salary, I didn’t realize that it wasn’t a direct replacement.
Running a business comes with additional financial responsibilities that service-based business owners must account for in not just how they pay themselves, but how they price their services.
When I first started this business, it was different than the way I was used to earning. Each week, my paycheck would show up with healthcare paid for, retirement deducted, taxes taken out and plenty of salary to put in the bank.
But this isn’t how it works when you’re responsible for your own paycheck.
What you earn needs to support not just you, but the business operations too.
For example, here’s how Profit First will help you pay yourself $100,000 in salary.
$100k in revenue is a goal that many small business owners might have in mind during their journey.
But $100 in revenue won’t pay you a salary of $100k.
What does bring in s $100k salary is $250k in revenue.
(Here’s how to use Profit First to set a revenue goal).
Here is a breakdown of what your business looks like when it’s implementing Profit First:
Based on the Profit First methodology, if your business brings in $100,000 it gets allocated in the following way:
Profit: 5% or $5,000
CEO Pay: 50% or $50,000 — alarm bells should be going off right now.
Taxes: $15,000
Opex: $30,000 That’s $2,500 in monthly operating expenses.
Here’s how $250K in revenue breaks down to a 6 figure salary using Profit First:
Profit 5%: $12,500
CEO Pay: $125,000
Taxes: $37,500
Opex: $75,000 (or $6,250 per month which gives you growth capital, marketing, and team).
Using Profit First as a framework for your revenue goals allows you to reverse engineer what you need to charge for your services, how much you should save for taxes, and what you have left to hire support.
This is an unpopular conversation (especially in the online business space, where revenue is hailed as the ultimate vanity objective) – but it’s one that we need to be having.
Yu see, any business owners get overly focused on chasing new leads – on marketing, on being “visible”, on all the things they think they need to do -except keeping track of their actual financial metrics
This is where simple math and the Profit First system can be incredibly useful for women small business owners who might not feel confident managing their money.
Hi, I’m Tara Newman.
I’m an expert in business growth strategies and organizational psychology.
I’m also a Profit First Certified Consultant.
It’s my goal to help you create significant income, and leverage your business to generate real, tangible wealth for yourself .
When we profit, I truly believe our entire world benefits.
What I’m interested in helping you do is pay yourself well, profit wisely, and invest in your net worth all without losing sight of your mental, emotional and energetic wealth.
I do this by teaching, mentoring, and coaching small business owners around sales, revenue generation, profitability, and simple business strategies, and Profit First is at the heart of the way we operate.
Bold Takeaways::
- Profit First is a pay yourself first, revenue – profit = expenses cashflow system.
- Profit First uses Parkinson’s Law to become an asset.
- Profit First can be incrdibly useful for women small business owners who aren’t confident managing their business finances.
Further Resources:
This podcast playlist has all the Profit First episodes from The Bold Money Podcast is one place.
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