What is Profit First? Profit first is budget program to help owners have the money to pay themselves, pay their taxes, have money in reserves, and be able to pay their operating expenses. The Profit First formula is Sales – Profits = Expenses which is the opposite of the GAAP (Generally Accepted Accounting Principles) formula for determining a business’s profit. The GAAP is logically accurate but it doesn’t account for human behavior. Most people will spend all their money and they don’t know where the money went.
With Profit First, you take a predetermined percentage of profits from the sales first before paying any expenses. I know what you are thinking because I thought the same thing when I first heard it. I have to pay my bills to avoid penalties. When you take the predetermined profit from the revenue sales first, it forces a business to know what their costs are and how it is helping their business grow.
What’s the first thing you do when you get to work in the morning? Do you check your bank balance to see how much money you have and make financial decisions based on the bank balance? Human nature is to consume everything on their plate or in the bank account and bank balance accounting will destroy your business just like eating to much will destroy your goal of losing weight.
Profit First reduces the size of the plate into smaller plates which makes owners take a hard look at which costs are necessary for growing the business. This is done by starting three accounts at Bank 1 and two accounts at Bank 2. Bank 1 will have your Income account, Owner’s Pay account, and your Operating Expense account. These accounts will be checking accounts and the accounts at the second bank will be savings account. Bank 2 accounts will be the Profit and Tax accounts. It is important that these two accounts are at a separate bank to make it harder to have immediate access to the funds so that the money is saved.
In order to determine the predetermined percentages, the prior 12 months need to be analyzed to determine the percentages paid for owner’s pay, taxes, operating expenses, and profits. Once these numbers are shown, then the predetermined percentages will be set by adding 1% to the current percentage for each area based on the prior 12 months. For example: most profit on the income statement is Sales – Expenses = Profits but the bank account is usually less than the income statement so the Profit Percentage will start with 1% of all sales revenue. Here’s an example:
Sales: $8,000 comes into the income account.
Profit 1%: Put $80 in the Profit savings account.
Tax 5%: Put $400 in the Tax Savings account
Owners Pay 50%: Put $4,000 paid to the owner. This should be split into two payments for each month.
Operating Expense 44%: Put $3,520 in the Operating Expense Account
These are made up numbers are not actual numbers because each business is different and needs to be analyzed. When switching to the Profit First method it will need to be done with baby steps and analyzed every quarter until the percentages are able to reached for optimal performance.
Each quarter, the owner will take 50% from the Profit account as a bonus for the blood, sweat, and tears invested in the business. The same thing goes with the Tax account. At the end of the year, if there is money left in the tax account and the tax liability has been paid, the owner receives the extra as a bonus or it can be left in the tax account for the next years tax liability.
This is a very brief over view of the methodology of Profit First. Expenses are brought under control and each expense is analyzed to see if it is helping or hurting the business growth. Knowing what money is coming in and going out on a regular basis gives you clarity on your cash flow and allows you to make projections for the future. Are you ready to make the change to reach or exceed your goals?