Looking to ensure that your small business is profitable? It all starts with properly setting up and knowing your finances. This can be overwhelming but it doesn't have to be. In this article I share how to get set up for profitability in your small business as well as an overview of the Profit First Method by Mike Michalowicz which will set you up for true financial success.
*FREE Business Finances Tracker Download*
Separate Your Personal & Business Finances
If you don’t have a business bank account, this is an important step because you need to separate your personal and business finances. This not only allows for an easier time with accounting in your business but also covers you from a legal perspective.
If your business and personal finances are connected, that means that if someone sues your company they could end up taking your personal assets (ex: your home). However, if you have a legal separation between the two, the person suing your company couldn’t take your personal finances/assets.
*Here is a great article from Relay that outlines these details.
Below are the steps to take to set up your business bank accounts (this information is for businesses in the United States but you can use the equivalent in other countries).
Step 1: Register your business (this is typically an LLC and you’ll need to do this for the state you live in. Simple google “how to set up an LLC in (insert state)” and follow the steps)
Step 2: Receive your EIN (Employer Identification Number) by filing for this once you have registered your business (here is a link for those in the United States)
Step 3: Set up a business bank account
*Suggestion: read the rest of this article and the Profit First book before doing this as you will need to set up multiple accounts if you use this method.
Implement The Profit First Method To Ensure Profitability In Your Small Business
Profit First is a concept for accounting in your small business and it’s laid out in the book, Profit First, by Mike Michalowicz. *You can purchase his book here or wherever books are sold.
The Profit First Method challenges the traditional way of looking at finances.
Traditional is:
Sales - Expenses = Profit
Profit First is:
Sales - Profit = Expenses
Mike created this method after hitting very tough times in business that even led to one of his kids recognizing the financial stress and brought him a piggy bank. From that moment on he committed to working with finances differently and is now on a mission to “eradicate entrepreneurship poverty”.
His method is “built for humans” because humans are emotional, not logical, and in general we will spend money if we have it. Therefore his method flips traditional accounting on its head so that you become profitable by not spending all your profit.
The Profit First Method teaches you how to break down your revenue into categories, much like you probably do with your personal budget. For example, in your personal budget you may have: groceries, mortgage, eating out, household bills, etc.
By following the Profit First Method, you’ll break things down into categories for your business:
Profit
Taxes
OPEX (Operating Expenses)
Owners Pay
That’s right, you will pay yourself when you use this method!
“Profit is not an event. Profit is not something that happens at the 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.” - Mike Michalowicz
Purchase your copy of Profit First and learn even more about this method and how you can ensure profitability in your small business.
Profit First Principles For Small Business Owners
Before sharing how to use this method, I wanted to share the four core principles outlined by Mike in the Profit First book. He uses food as an analogy and it really helps get a better understanding.
Use Small Plates
If you have a smaller plate, you’re likely to have smaller food portions and therefore fewer calories. If you take in less calories you typically lose weight. Right?
Same thing applies with money. If you have a smaller amount on a “plate” you will look at it differently and spend less. This helps with expenses!
Serve Sequentially
The order in which you do things matters. In the food example, if you eat veggies first and then mac and cheese, you will be more full from the veggies and eat less mac and cheese. Simply by changing the order, you can change the outcome.
This is why we look at taking out profit before expenses, it’s the veggies of the meal!
Remove Temptation
If something isn’t available to you, you’re less likely to use it/eat it. It will take more effort to go to the store and buy a cake or even bake a cake than it would to simply eat the cake on the counter.
By removing some of your money from your immediate “reach” it helps you create more boundaries which leads to better money management.
Enforce a Rhythm
If you wait until you’re super hungry to eat, you will likely eat more than intended but if you plan ahead, you typically make better choices with food. This is the same for money.
By knowing your numbers and having a rhythm that you follow each month, you will ensure better financial health in your business.
How To Implement Profit First In Your Small Business
Now you know the basics and it’s time to actually think about how this works in your small business. Think about a single client transaction that occurs in your business, for example, you’re a health coach and someone books a 1-hour session with you and pays you $100.
When that hits your bank account it’s a business revenue transaction. CONGRATS!!!
And now based on the categories that are included in the Profit First Method, you’ll take that transaction and break it down based on a percentage that you determine is best for your business. For example:
Profit - start at 1%
Taxes - estimate 20% but do the math for your location
OPEX - goal is 30% but you might be higher or lower than this
Owners Pay - 49% is left over, aim for 30 - 50% but it’s critical to pay yourself! This cannot be zero. Period.
Single Transaction Example:
Transaction = $100.00
Profit - $1
Taxes - $20
OPEX - $30
Owners Pay - $49
Of course you won’t do this for every single transaction but instead you’ll go through this process 2 times a month (Mike suggests the 10th and 25th each month). You’ll take the total revenue that has come into your business income account and then break it down by the percentages you’ve decided upon.
How To Manage Your Business Finances The Profit First Way
Remember when I said to read this article before setting up your business bank account? This section is why you want to do that and it’s because it’s actually easier to use this method if you set up multiple bank accounts.
If you’re familiar with the “envelope system” for budgeting, it’s really similar. But instead of envelopes you use bank accounts.
First, you want to find a bank that will allow you to have multiple accounts without a ton of fees and you’re able to take your bank balance down to ZERO without incurring any fees.
Second, you will get 5 bank accounts set up to get started. Once you have the 5 accounts set up, you can name them so that you can quickly see all accounts in a glance:
Income
Profit
Taxes
OPEX
Owners Pay
All your revenue should funnel into the INCOME account.
All your bills should be paid from the OPEX account.
You’ll hold your tax payment in the TAX account and pay quarterly taxes.
*Note: There are other ways to do this and a specific bank that works well with this system. Relay is the official Profit First bank and is set up with these categories specifically. Also, YNAB is a system that you can connect to your existing bank instead of setting up multiple accounts. I recommend learning from Amber Dugger to use this method.
Monthly Accounting in Your Small Business So You Stay Profitable & Pay Yourself As The Owner
If you follow this method, each month on the 10th and 25th you will do your bi-monthly accounting work. This will feel a bit overwhelming at first but you’ll find your groove with this and it will take about an hour of your time twice a month. You can absolutely do this, even if you don’t feel like a “financial savvy” person.
If thinking about your expenses and income makes you a bit nervous, remember you can keep this super simple by using a spreadsheet.
*I’ve created a FREE spreadsheet for you too! Use the form below to download the spreadsheet and video tutorial on how to use it.
Step 1: Track your income for the timeframe
Before you can break things down into the percentages that you determined for your unique small business, you have to know how much revenue your business has brought in during this time frame.
For this step, simply look at your INCOME bank account and record the transactions in your spreadsheet or categorize it in your accounting software (Quickbooks, Freshbooks, Xero, etc.)
Pro Tip: It’s helpful to break your income down into revenue streams (ex: one on one client work, digital course sales, etc.) so that you’re aware of which revenue stream is performing the best for you.
Step 2: Track your expenses for the timeframe
Just like you track your revenue, you also need to track your expenses to see if you’re on target for the percentage you set for OPEX. To record/categorize these transactions you can look in your accounting software or look in the OPEX bank account since that’s where you will pay for expenses.
Chances are you will be off of your percentage when you’re first starting to track all of your finances. That’s okay! Take note of what the actual percentage is and how far off you are from your target. Then you have something to work towards or you can adjust your percentages to be more realistic.
Step 3: Break down the percentages according to Profit First
Take the total amount of revenue acquired in that time frame and use that to identify the amounts to allocate to each category.
For example:
Income/Revenue Total = $5,678
Profit (1%) = $56.78
Taxes (20%) = $1,135.60
OPEX (30%) = $1,703.39
Owners Pay (49%) = $2,782.22
Step 4: Move Your Money Around
Once you know the percentages for Profit, Owner’s Pay, OPEX, and Taxes, it’s time to transfer money. Make sure everything adds up correctly and then simply transfer your money from one account to another. Everything will come out of the INCOME account and you will be left with ZERO in that account.
You will repeat this process 2 times per month (the 10th and 25th) and find your groove with this. This will eventually take you about an hour but the first few times you do this it will take a bit longer. Give it time, it’s worth it.
The goal is that at a glance you will know exactly how much you have in each account and you don’t have to do any math, you pay yourself consistently and your business stays profitable.
How Profit First Works with Non-Consistent Income
This process works no matter what your income is each month because it’s based on each transaction. The difference is that when your income varies each month, it’s harder to identify the best percentage for expenses in business.
However, by simply starting to track your monthly income and expenses, you will start to see how much each revenue stream is bringing you and can make adjustments to your percentages.
Take Away Message / Action
If you’d like to learn even more about the Profit First Method, please be sure to buy Mike’s book: Profit First.
Start tracking your business revenue and expenses in a spreadsheet (click here to download the free tracking spreadsheet) on a monthly basis.
Set up your business bank accounts according to the Profit First Method so you can ensure profitability in your small business.
Remember that this is a new habit you’re implementing and it will take time to find your groove. Give it time and patience because it will pay off (literally) in the end.
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I help women who stumbled into entrepreneurship, get out of the weeds and create a sustainable, organized business they are proud of and provides the flexibility they desire.
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Hear from just one of my happy (and profitable!) clients:
"After looking at my finances, the profit so far this year is twice as much as last year. Thank you so much for all your support!" - Amy