It's a good way of thinking about accounting and making money, but it's both simplistic and overly complicated. It also skews towards smaller, earlier businesses, and I'm not sure this would be a good philosophy if you wanted to grow something more substantial.
While my companies grew explosively, I still operated them on a check - to - check basis — and I had no idea that this was a problem. The point was to grow, right? Increase sales and the profit will take care of itself, right?
Money problems occur when one of two things happen:
Sales slow down. The problem here is obvious when you operate check-to-check and sales slow down: when your one big client goes out of business, or that big deal you were banking on falls through, you won’t have enough to cover expenses.
Sales speed up. This problem here is not obvious, but it is insidious. As your income climbs, expenses quickly follow. Big deposits feel great, but they are irregular. Consistent incoming cash flow is hard to sustain. A great quarter can trick you into believing your business is on a permanent upswing, and you start spending like this is the new normal. But drought periods come quickly and unexpectedly, causing a major gap in cash flow.
This is constant growth without concern for health. And the day that big sale or customer or investor doesn’t show, you will fall to the ground and curl up crying like a baby.
The perfect size for your business? It will happen naturally, when you take your profit first. You will reverse engineer all the elements of your business, and as Fried says, "the right size will find you."
Here’s the deal, my friend: Profit is not an event. Profit is not something that happens at year - end or at the end of your five - year plan or someday. Profit isn’t even something that waits until tomorrow. Profit must happen now and always. Profit must be baked into your business. Every day, every transaction, every moment. Profit is not an event. Profit is a habit.
You need to fix profit first, then grow. You must figure out the things that make profit and dump the things that don’t. When you focus on growth, it is inevitably a scramble to grow at all costs.
When you focus on profit first, you inevitably figure out how to make a profit consistently. Profitability. Stability. Sanity. Forevermore.
Accountants define profit differently than entrepreneurs. They point to a fictitious number at the bottom of an accounting report. Our definition of profit is simple: cash in the bank. Cold. Hard. Cash. For us.
Chapter 2: THE CORE PRINCIPLES OF PROFIT FIRST
The only time I would have a profit was when income jumped up, and I didn’t have time to spend at the same rate (point A). However, I would quickly ramp up my expenses to serve my "new level of sales" (point B). Then sales would settle back down, or drop, while my new level of expenses remained higher (point C), which meant I started to accumulate losses, making me desperate to sell more and sell faster at any cost (which could, in turn, further increase my expenses).
When less money is available to run your business, you will find ways to get the same or better results with less. By taking your profit first, you will be forced to think smarter and innovate more.
When profit comes first, it is the focus, and it is never forgotten.
As you implement Profit First, you are going to use the powerful force of "out of sight, out of mind." As you generate a profit (which, remember, starts today), you are going to remove the money from your immediate access. You won’t see it, so you won’t access it.
To grow the biggest and the fastest, you need to be the best at one thing you do. And to become the best at something, you need to first determine what you are best at and do it a whole lot better. To get there, you take your profit first and the answers to being the best at something will reveal themselves.
THE NEW ACCOUNTING FORMULA Now you know the psychology behind how you work. The next step is to put a system around the normal you. And we start with a simple new Profit First formula: Sales − Profit = Expenses
Eliminating unnecessary expenses will bring more health to your business than you can ever imagine.
Do your allocations and payables twice a month (specifically, on the tenth and twenty - fifth).
After setting up this new checking account at your bank, nickname the account PROFIT, and from this moment forward from any deposit you put into your normal checking account, transfer 1 percent of that deposit into your PROFIT account.
Chapter 3: SETTING UP PROFIT FIRST FOR YOUR BUSINESS
When our balance is low, we make collection calls and sell hard. When our balance is high, we invest in equipment and expansion. It works. Kinda.
Here are the five checking accounts you need to set up:
Set up two more external savings accounts with a bank other than the bank you use for daily operations. One account will be your no-temptation PROFIT HOLD account. The second will be your no-temptation TAX HOLD account. Set them up with the ability to withdraw money directly from the respective checking accounts at your primary bank.
Chapter 5: ALLOCATION PERCENTAGES
The bigger your profit allocation percentage, the more efficiently you are running your business, which means less in operating expenses. So not only do you have more saved up with a higher PF percentage, you spend less, which affords you even more time.
Tax account: simply use 35 percent for U.S. - based businesses
For the remainder of this quarter, set your CAPs 1 percent "better" than what you have done historically — meaning increase your Profit, Owner’s Comp, and Tax all by 1 percent and cut your Operating Expenses by 3 percent.
Chapter 6: PUTTING PROFIT FIRST INTO MOTION
There are only two ways to do that: by increasing sales and cutting expenses. Increasing sales is very doable (you did read The Pumpkin Plan and Surge, right?), and is the key for colossal profitable growth. But it takes time and it won’t happen overnight. Cutting expenses is generally a very quick process and is usually very easy.
Tally the total amount of profit in the account (don’t add any quarterly distribution percentages from deposits you received this day, yet) and take 50 percent of the money as profit. The other 50 percent remains in the account, as a reserve.
the ideal three-month cash reserve for your business, the place where you have enough cash saved to operate your business unscathed for three months if all sales came to a screeching halt and not another penny came into the business? Well, the PROFIT account is where this reserve accumulates, just for that circumstance.
Chapter 7: DESTROY YOUR DEBT
When you base decisions on your best revenue month, you will run out of cash — quickly. Debt will start to pile up. And you will go back to your old standby, "Sell more — grow, grow, grow!" Acting as if your best month is the norm is one surefire way to keep yourself locked in the Survival Trap.
Start the Debt Freeze. Stop any recurring payments and kill off anything you don’t need. Do whatever it takes to get your "monthly nut" down to 10 percent lower than your Instant Assessment suggests it should be.
Chapter 8: FIND MONEY WITHIN YOUR BUSINESS
I want you to set a massive goal for yourself. Look at every aspect of your business and determine how to get two times the results with half the effort. That’s a biggie, so I will say it again: How do you get two times the results with half the effort?
Chapter 9: PROFIT FIRST—ADVANCED TECHNIQUES
For each full - time employee, your company should generate Real Revenue of $ 150,000 to $ 250,000 (ideally more, but this is the minimum).
Chapter 10: THE PROFIT FIRST LIFE
What I am telling you is, in order for Profit First to have a permanent impact on your life, you need to build as big a gap as possible between what you earn and what you spend.
Here are five rules to help you stay locked in to your lifestyle for the next five years:
The idea of the Wedge is to only gradually (and mindfully) upgrade your lifestyle as your income increases. Every time your income increases, you set aside half of the increase as savings so that you don’t expand your lifestyle to, as Parkinson’s Law suggests, "use all available resources."
I don’t gift my kids an allowance. Instead, I set up a job list (a variant on chores) with corresponding pay rates and post it on the refrigerator.
Then consider joining the 22,000 other people getting the Monday Medley newsletter. It's a collection of fascinating finds from my week, usually about psychology, technology, health, philosophy, and whatever else catches my interest. I also include new articles, and book notes.