A new movement is happening for small businesses that deals with how they handle banking.
While accounting practices may seem fairly dull to most people, a book by Mike Michalowicz titled “Profit First: Transform Your Business From a Cash Eating Monster to a Profit Making Machine” has everyone talking. According to Ron Saharyan with the “Profit First Professionals” group, about 75,000 small businesses globally are on this path. Is your shop?
The premise of the book is to change how most businesses handle their money. The conventional accounting method for operating any business is to deduct expenses from sales to calculate profit (Sales – Expenses = Profit).
Profit First flips that. Michalowicz’s formula calculates expenses by deducting profit from sales (Sales – Profit = Expenses).
That’s right — as the business owner, you pay yourself first. The company operates daily from the remainder.
Does this method sound reasonable? Just as dieters can use portion control to lose weight by eating from smaller plates, businesses can enhance their ability to build more profit if finances are limited.
It’s a very interesting premise. But does it work?
Let’s explore the Profit First phenomenon in the decorated-apparel industry and get thoughts on the method from
industry veteran Mark Coudray, a certified Profit First Professional who has been helping shops with implementation.
The Profit First Idea
The Profit First system is based on doing something that isn’t obvious: Instead of operating the business with one or two bank accounts, several are created. In addition, fee-free accounts are required. For that reason, business owners commonly switch banks.
Five separate business checking accounts will be needed. These five accounts are nicknamed: Income, Profit, Owner’s Comp, Tax, and Opex (Operating).
Then, at a different bank, two savings accounts are set up. These are named Profit Hold and Tax Hold. By using a different bank, any temptation to “borrow” from these accounts is curtailed. In fact, Michalowicz suggests getting those that require a second signature for withdrawals.
Once these bank accounts are set up, the real fun begins. Using the Profit First system, the business will set up target allocation percentages (or TAPs) by working through the book’s Instant Assessment for the business. For the first quarter, the company will implement current allocation percentages (or CAPs) that will be built so that the business can properly manage its finances. These percentages will allocate funds to the various new bank accounts.
Each day, all incoming sales will be deposited into the Income account.
Twice Per Month
On the 10th and 25th days of each month, all funds that have accumulated in the Income account are dispersed to the Profit, Owner’s Comp, Tax and Opex accounts, based on the CAP percentages that already are set up.
All money in the Profit account is swept into the Profit Hold savings account at a different bank. Likewise, all money in the Tax account gets swept into the Tax Savings account, leaving a $0 balance in the Profit and Tax checking accounts.
Next, the business owner’s salary is paid from the Owner’s Comp account. Employee payroll and all bills are paid from the Opex account.
Each Quarter
Every quarter, 50% of the funds that have accumulated in the Profit Hold account are dispersed to the owner. Michalowicz makes a strong point that this money is for business owners and should not be reinvested into the business. The owners are taking the risk and should reap the reward.
Also, tax liabilities are paid through the Tax Hold savings account.
Finally, Michalowicz suggests that companies meet with their accountants or Profit First Professionals to adjust the CAPs for the Profit, Tax, Owner’s Comp and Opex accounts to maximize the company’s financial health.
A good recommendation for any business owner who doesn’t have a knack for accounting systems is to get guidance. The Profit First system can be challenging, especially when creating TAPs or CAPs.
Spawned from the book is a certification program that produces Profit First Professionals for the purpose of helping others with the system. One of our industry’s leading minds, Coudray has achieved the certification and has been helping shops with Profit First implementation.
Impressions asked him to give his take on the system. Following is what he had to say:
Impressions: What is a Profit First Professional and what do you do that someone can’t implement by reading the book?
Coudray: Profit First Professionals are accountants, bookkeepers, consultants and business coaches who have gone through six months of training and passed the certification exam. They also have to be successfully using Profit First in their own businesses. They are trained at a deeper level than the book goes into. Typically, they will specialize in one niche industry and are experts in cost and profit behavior for that industry.
Impressions: What recommendations for TAPs and CAPs would you advise a shop to start with until they dial everything in?
Coudray: That is difficult to say, as there are many surrounding factors to consider. For example, if the business is too heavily debt-laden, there is a special plan to retire the debt quickly and reduce bank-interest expense. Repayment of debt comes from future profits, something no one talks about. The only expense portion that is deductible is the interest expense. The key reality check is for an owner to start paying themselves right away a salary equal to what it would cost to hire some who did the same job. This is usually a big shock and most young companies pay themselves last, and still hope for a profit.
Impressions: What is one drawback or downside to implementing Profit First for shops?
Coudray: It is one more thing to keep track of. So many of the companies I work with are busy being busy with work that is not effective. When you focus on cash generation and profit, you quickly learn how to refine your business practices to be more effective and become more financially stable and secure.
Impressions: Have you seen bigger profits to you, the owner, than with previous accounting methods?
Coudray: Yes, the Profit First system really gets you to focus on the money engine of your business and the decisions you make that affect cash flow, as well as how you compensate yourself. The key is to get started with something, even if it is minimum wage for a salary and 1% for profit. You quickly see how inadequate that is, and it is easy and motivating to take the corrective action.
If this all sounds intriguing, I suggest reading Profit First. A lot of essential details and insights about how to make this method work are included in the book.
How is it working for shops in the industry? Next month, in Part 2 of this series, we’ll get feedback from some shop owners who currently are using this method. We’ll also have a final word from Saharyan regarding the overall picture for small businesses using this system.
Marshall Atkinson, owner of Atkinson Consulting LLC, is a decorated-apparel industry production and efficiency expert who focuses on operational efficiency, continuous improvement, workflow strategy, business planning and more. For more information or to comment on this article, email Marshall at [email protected].
