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Profit First by Mike Michalowicz
Profit First by Mike Michalowicz

Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine is one of my favorite business books. I first read it in 2018, then read it again in 2022 so I could write this review. Profit First has made a HUGE difference in my business and I highly recommend it (plus, it’s entertaining).

What’s Wrong

The typical (old school) profit formula is Sales – Expenses = Profit. “Sell as much as you can, then pay the bills, and what is left over is profit. Here’s the problem: there are never any leftovers.”

The author has a new formula for us though: Sales – Profit = Expenses.

Before he dives into how it works, he talks about why it works.

There are common pain points business owners may face:

  • We learn how to do all the things, but we might not have learned how to keep the money we collect
  • After a good quarter, our spending may increase and cutting back can be difficult when we’re on the downswing
  • We believe in growth growth growth, but aren’t sure to what end
  • Decisions are made based on the total in our bank account

I love the story in the book about Ernie, the lawn guy. In need of more revenue, Ernie notices that Mike needs his gutters cleaned and shingles repaired. Mike says okay, and Ernie proceeds to purchase all of the supplies he needs to clean the gutters and repair the shingles. What Ernie does not do, though is:

  • Consider the vision he wants for his company
  • Think about the opportunity cost
  • Understand income vs. debt-generating income
  • Become really efficient (and super profitable) doing lawns

Ernie is stuck in the survival trap. He’s at point A (crisis) and wants to get to point B (vision), but he’s going about it the wrong way — by offering new products, taking on unfit projects, running last minute promotions to generate cash, and so on.

The author talks about GAAP (traditional accounting), but because I’m not familiar with it, it was a little like noise to me. If you’re familiar with GAAP, you can read all about why Profit First is a better system.

Smaller Plates

In 2015, I was looking for a better way to manage my money. I stumbled across YNAB on Reddit and everything changed for me. With YNAB, you take a larger bucket of money (your entire checking or savings account) and break it into smaller pieces (categories). You also work with REAL money — money that you actually have and not money that you expect. (A bird in the hand and all that good stuff.)

Profit First is no different. It’s similar to the small plate theory (if you want to lose weight, use smaller plates), 401ks (people don’t miss money when it’s taken out automatically pre-check) or the envelope system. If you want to save more money, don’t look at the big chunk – look at the individual pieces.

What are those pieces? I’m glad you asked. They are:

  • Income
  • Profit (first)
  • Owner’s Compensation
  • Taxes
  • Operating Expenses

And the four principles are:

  1. Use small plates (use Parkinson’s Law to your advantage — when you think you have less, you’ll make do with less)
  2. Serve sequentially (focusing on profit first will ensure you don’t forget about it)
  3. Remove temptation (make some of that money hard to access)
  4. Enforce a rhythm (manage and move money regularly, but not too often)

Start Today

What’s great about this book is that you don’t have to read the whole thing before taking action. In Chapter 2, the author directs you to open a new account and for any deposit you put into your normal checking account, move 1% to the profit account. You’ll never miss it, but you’ll be amazed to see how quickly it grows.

Additional Accounts

Once your profit account is rolling, you can get started on the next steps. The author recommends five checking accounts (yes, five) and two “no-temptation” accounts at another bank. It sounds like a lot of accounts (because it is), but he explains why they’re necessary.

Percentages

As you’ll be moving money between accounts, you’ll need to know how much to move. The author has an instant assessment tool (see the resources below for a copy) that you can use to see where you stand and to determine your TAPs (Target Allocation Percentages). This part seems difficult and scary, but try not to get bogged down in the details.

There’s an example in the book of a completed assessment for a law firm. The target allocation percentages are:

  • Profit – 10%
  • Owner’s Compensation – 10%
  • Tax – 15%
  • Operating Expenses – 65%

Brand new businesses may have these percentages:

  • Profit – 1%
  • Owner’s Compensation – 50%
  • Tax – 15%
  • Operating Expenses – 34%

Most businesses will not be able to move money based on those percentages from day one. What you’re able to move (percentage-wise) will be known as your CAPs (Current Allocation Percentages).

It will take time to get to the desired targets (and remember, your targets may be different). There’s a ton of good information in the book about how to get from where you are to where you want to be.

Making Your Moves

The author recommends moving money on the 10th and 25th of the month:

  • All money would start in income
  • Move money to Profit, Owner’s Compensation, Tax and Operating Expenses (based on current allocation percentages)
  • The income account will now be empty as everything has been allocated
  • Transfer money from Profit to Profit Hold and Tax to Tax Hold (the hold accounts are those at your other bank that are difficult to access)
  • Take a biweekly salary from Owner’s Compensation (if there’s extra, leave the rest)

Quarterly, you’ll take your profit (50% of what’s in the account to be used for your personal benefit only), pay your taxes and reevaluate your percentages.

What about Debt?

If you’re in debt, you’ll follow most of what’s outlined above but 99% of the profit distribution you take should go towards debt; the other 1% goes to you.

Apparently the author finds a lot of inspiration channel surfing at random times. During one of those times, he was watching Suze Orman, and she said, “If you want to get out of debt, you must get more enjoyment out of saving money than you do spending money.” I couldn’t agree more, Suze.

You’ll also want to do a debt freeze, which the author walks you through in Chapter 7.

Other Good Stuff

The book also discusses:

  • Ways to find money in your business — by becoming more efficient, chipping away at expenses, firing bad clients, cloning your best clients and selling smarter
  • Advanced Profit First techniques — additional accounts, raising capital, how to determine whether you can afford a new employee and some power tactics
  • How to “lock in your lifestyle” — no matter how good things get, you won’t increase your lifestyle in response
  • Teaching your kids about money
  • Mistakes people make with Profit First

How I Use Profit First

While I love the principles of Profit First, I don’t follow it to a T. I use it as more like a set of guidelines on how to manage my business finances.

I have a set of business accounts at a credit union — a checking, a savings and a money market. I also have another savings account at a separate bank for a total of four accounts. Here’s how I use the accounts:

  • Checking = incoming invoices, outgoing standard expenses
  • Savings = owner pay
  • Money market = taxes
  • Other savings = profit

All money goes into my checking account. From there, I move money to owner pay, taxes and profit once per month. Everything left in the account is for expenses.

I encourage you to find what works for you. Profit First is a great system and you can definitely use it exactly as the author intends, but don’t feel bad if you go off script a little bit.

Additional Resources

Want to talk about finances? Hit me up on Twitter.

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