Looking to create a thriving business? It all starts with your finances and I know that can be overwhelming but it doesn't have to be. By implementing the Profit First method (Mike Michalowicz) it's as easy as setting a few percentages.
What’s Profit First?
Profit First is a concept for accounting in your business and it’s laid out in a book, Profit First, by Mike Michalowicz.
This is not my process so please be sure to go buy his book wherever books are sold. Trust me, this is the best $20 you’ll spend in your business and I have no connection to that purchase whatsoever.
I hope to be the official “Profit First” teacher for yoga teachers but I’m working on that. Until then, I’m sharing what I know in this podcast episode so you can implement this ASAP because the sooner you can, the better!
The concept of Profit First challenges the traditional way of looking at finances.
Traditional is:
Sales - Expenses = Profit
Profit First is:
Sales - Profit = Expenses
Mike shares this concept because he had some rough times with money. He shares a story about his kid bringing him a piggy bank with money to help him out and from that moment on, he committed to doing money differently.
He created this system and he says it’s “built for humans” because humans are emotional, not logical and we will spend money if we have it, in general. So the idea is that we won’t have a profit if we use it all for expenses. So we need to take a profit first. Get it…. =)
**This was also a podcast interview. If you prefer to listen to this, use the player below.
Profit First Principles
First, I highly, highly, highly recommend that you buy the paper book of Mike’s - Profit First. (I’ve heard it’s hard to process in audio version but that’s available too) Read the first 8 chapters and then stop. He even says to do this too. Seriously, STOP after chapter 8 because the rest is advanced and you don’t need it right away. Put the book away!
I’m going to share the overall idea but there’s not replacement for his book so do yourself a favor and buy the book.
Here are 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
Here’s what we know - if you have a smaller plate, you’re likely to have smaller portions and therefore fewer calories. If you take in less calories you typically lose weight. Right? Same thing happens 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 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 Profit First Works
Now you know the basics and it’s time to actually think about how this works in your business. I want you to think about any transaction that happens in your bank account.
***Side note: if you don’t have a business bank account, this is step 2 in the process. (1) Buy the book. (2) Set up a business bank account. You’re running a business and you need a business bank account.***
If someone pays for a private session it goes through your payment system, your payment processor takes a percentage of that transaction, then the rest is deposited into your bank account. BINGO!
Let’s say that transaction that hits your bank account is $100.00 (it won’t be a round number like this in real life but it’s easier to show as an example)
Using the Profit First method, what you would do is break that individual transaction into 4 buckets based on percentages:
The Four Buckets:
Profit
Owners Pay
OPEX (Operating Expenses)
Taxes
Mike goes into detail about how to get to the specific percentages for your business and I recommend that you go through his process but here is an example so you can see how this breaks down.
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, look at your expenses!
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
Owners Pay - $49
OPEX - $30
Taxes - $20
This is the overall idea of Profit First - you take each transaction and split it up intentionally.
In reality, Mike doesn’t want us doing this transaction by transaction and neither do I, but rather two times a month you do your accounting and take the total income you have and break it into percentages.
Monthly Income Example:
Group Classes = $400; Private Sessions = $800; Workshop = $300 = TOTAL = $1,500
Profit - $15
Owners Pay - $735
OPEX - $450
Taxes - $300
How to Manage The Buckets of Money
Mike shares a way, and I also use this way, to manage all these buckets for your money. If you’re familiar with the “envelope system” for budgeting, it’s really similar. But instead of envelopes you use bank accounts.
That’s right - you will have multiple bank accounts to help you manage all this. But hang with me because it’s actually easier than you think.
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 to 7 accounts set up to get started. If you use Mike’s method you will need at least 5 accounts but there’s also an option for 7 accounts with 2 being at another bank. This is for super safe keeping so it’s harder to get to the money. Like not buying the cake mix at the store.
Once you have the 5 accounts set up, you will name them so that you can quickly see all accounts in a glance:
Profit
Owners Pay
OPEX - where you’re bills will be paid, if you have auto payments, have them pull from here, not your income account
Taxes
Income - this will be the account that all revenue comes into from your payment processor
As long as you have these accounts set up and you aren’t charged a monthly fee or a fee for going down to zero, you’re in business!!!
Monthly Accounting in Your Business
Each month on the 10th and 25th of the month you will do your bi-monthly accounting work. What this looks like is taking about an hour out of your day on the 10th and 25th and moving money around.
If thinking about your expenses and income makes you a bit nervous, remember you can keep this super simple by using a spreadsheet.
Step 1: Track your expenses for the timeframe
This can look like you looking at your accounting software (Quickbooks, Freshbooks, Xero, etc) and categorizing your expenses or looking at your bank account and tracking this in a spreadsheet. You don’t need to get fancy, just know what you’re spending. The point of this step is to see what you spent money on during that timeframe in business. This helps you understand how much you’re spending and what percentage of your revenue is actually being used for expenses.
Step 2: Track your income for the timeframe
Just like you need to look at your expenses, you also need to review your income and track that too. This is as simple as looking at your Income account in your banking system online.
Step 3: Break down the percentages according to Profit First
Choose the system that works best for you but what this looks like for me is a spreadsheet. I have a formula figured out in a spreadsheet so all I have to do each 10th and 25th is add the INCOME total to one cell and it automatically populates each of the percentages. You make the math work for your percentages.
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 and find your groove with this. Like I said it 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.
Then at a glance you will know exactly how much you have each account and you don’t have to do any math!
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 budget for things in business.
By simply starting to track your monthly income, you will start to see how much each revenue stream is bringing you and can make adjustments. So maybe you notice that your registered series brings in more consistent income than your drop in classes AND it helps you gain private clients so that’s something you could potentially do more of. Maybe you decide to add another series time and stop running some of your drop in classes and you end up making more money in the end.
The idea is that you start to track your income and expenses so you can make the best financial decisions for your business. But it all starts with you starting this process!
Your next step
Order Profit First by Mike Michalowicz.
This was a brief intro to the idea that he has outlined in great detail. You will learn much more by reading his book so go get it and remember, read up to chapter 8 then stop. (Just like Mike says to do)
Until next time give yourself permission to put profit first and grace along the way. I’ll talk to you soon!
“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
****This is not an interview with Mike but I hope to have him on the podcast one day. Until then, here's my interpretation and overview of his book, Profit First.