Nearly 4 out of 5 small businesses fail in large part due to poor cash flow management. That sounds like bad news for small business owners, but there’s a way out: the Profit First cash management method. Below, you’ll discover how this modern approach can help you take a smarter approach to managing your money.
As the name suggests, Profit First accounting can help increase profit, which can stabilize your organization and help your business flourish without sacrificing growth. Here, we’ll help you understand how the profit first method works and how it can contribute to the financial health of your small business.
What you need to know
- The Profit First cash management method involves pre-emptively allocating some of your revenue as profit, before expenses.
- Profit First accounting can improve long-term cash flow and budget clarity while reducing financial stress, but it may not be suitable for businesses with thin margins or substantial debt.
- Start simply, with low fixed percentages, and scale as your business grows, ideally by using a banking platform that supports sub-accounts and automated transfers.
What is Profit First accounting?
Rather than chasing the next big sale or expansion, the Profit First cash management method flips the typical accounting process on its head and starts with setting profits aside before expenses.
With this method, you take a percentage from each sale as profit, and then focus on scaling your different expenses around what you’ve set aside. In other words, instead of immediately trying to account for expenses, you pre-emptively set aside some cash as profit, then allocate based on what you’ve set aside:
| Most business owners structure their budget like this: | With Profit First accounting, you’ll structure your budget like this: |
|---|---|
| Revenue – Expenses = Profit | Revenue – Profit = Expenses |
In a relatively short time, this method has earned acclaim from accountants and other financial professionals for introducing an innovative, effective budgeting strategy for business owners. This may sound counterintuitive at first, but if you focus your business around profit, everything else follows—including more profit.
Who wrote the Profit First book?
Profit First is a 2014 book by Mike Michalowicz, a former columnist for the Wall Street Journal and serial entrepreneur who launched three multi-million dollar companies before he turned 35. He set out to pass on what he’d learned through a series of best-selling books that outline a new way for business owners to think about revenue and profits.
In Profit First, Michalowicz lays out a strategy to “transform any business from a cash-eating monster to a money-making machine” (per the book’s subtitle). The book’s radically simple central idea came out of Michalowitz’s own struggles with maintaining cash flow with one of his earlier business ventures.
What are the pros and cons of the Profit First cash management method?
While the Profit First cash management method could help you boost your long-term profits, it’s important to weigh its advantages and limits. Follow these pointers to determine whether Profit First accounting is right for your business.
Benefits
- Prioritizes profits: By allocating profit before expenses, you’ll ensure your business is generating profit with every dollar earned.
- Improves cash flow: Distributing your revenue into different sub-accounts (profit, payroll, taxes, your salary, overhead costs, etc.) increases financial clarity and helps curb overspending.
- Enhances financial discipline: Profit First accounting creates clear spending limits and helps curb the excess or impulse spending that can drain your business checking account.
- Reduces financial stress: Accounting for your profit, taxes, and personal salary in advance makes your finances and forecasts more transparent, bringing peace of mind.
- Facilitates better decision making: Seeing your available funds in real time helps you make informed financial decisions and plan for contingencies.
Hurdles
- Could be difficult to set up: Converting your accounting to a different method can be time-consuming, and complex if your business checking provider doesn’t offer multiple sub-accounts.
- Tricky for businesses with high overhead costs: If your business operates with slim margins or high fixed expenses, setting aside profit first can feel needlessly complex while not conferring a significant effect.
- Challenging for businesses with a lot of debt: By prioritizing profit, your ability to repay debts will be slowed down, which can have consequences depending on the type of liability.
- Can take time: If your business checking provider doesn’t offer multiple sub-accounts or automatic transfer rules, you’ll have to spend a lot of time transferring funds and maintaining multiple business checking accounts.
Set up Profit First accounts with ease
With Bluevine Business Checking, you can create sub-accounts to separate budgets for expenses, emergencies, taxes, payroll, and more. You can also easily set up percentage-based automatic transfer rules to implement the Profit First strategy.
How does the Profit First Method work?
Here’s how you can set up this cash management method in just four steps.
1. Create a profit margin goal
First, decide what percentage of your business revenue you want to set aside as profit. If you’re a new or small business, start small (5 or 10%) and increase as you scale. If you’re an established business, choose a percentage that’s ambitious but realistic. This allocation will be the foundation for your new cash management strategy.
2. Set up your Profit First accounts
Open sub-accounts for your main spending categories. While you can always customize your sub-accounts to suit your business, Mike Michalowicz recommends these five: revenue, profit, taxes, operating expenses, and owner’s salary. Just as you did with your profit, choose what percentage of your revenue you want to allocate to each sub-account.
3. Distribute your revenue
Every two weeks (Michalowicz recommends the 10th and 25th of each month), transfer all revenue into your revenue sub-account. Then, based on the fixed percentages you chose, allocate your revenue into your other sub-accounts.
4. Pay from designated accounts
Separating your money makes it easier to budget and manage your finances at a glance. Only pay bills from the designated sub-account—for example, never pay your salary from the operating expenses sub-account, or taxes from the profit sub-account. If you need more money in a particular sub-account, adjust your allocation strategy.
How can you optimize your banking practices for Profit First?
Using the Profit First method requires having strong control over your cash flow and being able to adequately separate out money based on different buckets. The best way to achieve that is to distribute your funds into your main account and five separate sub-accounts:
- Income: Your main business checking account holds the revenue that your business earns. You can optimize for Profit First by allocating a set percentage from your revenue earned to count toward your business’s profitability.
- Payroll: This sub-account is where your team’s salaries and wages would go.
- Tax savings: This sub-account is where you’ll set aside a fixed amount to go toward taxes.
- Operating expenses: This account holds cash meant to go toward salaries, rent, office supplies, business travel, and other bills etc.
- Marketing expenses: This sub-account would be where you’d keep your marketing budget.
- Emergency: You would use this sub-account to save money for unexpected expenses and emergencies.
Because separate accounts are so central to the Profit First strategy, it’s important to look for a bank or banking platform that supports easy account management, like the ability to open a series of sub-accounts under your main account. You can start small by simply designating accounts for ‘Operating expenses’ and ‘Tax savings,’ then work toward adding the others as your business grows.
Some of the best business checking accounts even give you the power to set up automatic transfer rules between your main account and sub-accounts, so you can automatically transfer a percentage of your balance to an ‘Income’ sub-account or your main account if that’s where you decide to keep profits.
How much should go into each separate account?
Figuring out how much of your cash should flow into each of the aforementioned accounts starts with first understanding two types of goals: current allocation percentages (CAPs) and target allocation percentages (TAPs).
Your CAPs reveal how your money is being spent right now, based on your current income and expenses. Your TAPs, on the other hand, reveal your desired budget and show what your business would look like if it were operating at peak performance and efficiency.
Michalowitz helps break down allocations based on TAPs, with examples of adjusted percentages based on your business’s yearly income:
| Real Revenue Range | $0-$250k | $250-$500k | $500k-$1M | $1M-$5M | $5M-$10M | $10M-$50M |
| Real Revenue | 100% | 100% | 100% | 100% | 100% | 100% |
| Profit | 5% | 10% | 15% | 10% | 15% | 20% |
| Owner’s Pay | 50% | 35% | 20% | 10% | 5% | 0% |
| Taxes | 15% | 15% | 15% | 15% | 15% | 15% |
| Operating Expenses | 30% | 40% | 50% | 65% | 65% | 65% |
Your allocations will change as your business grows and starts bringing in more revenue. For example, as you scale, you’ll put a higher percentage toward operating expenses and a lower percentage toward your personal salary. For this method to be effective, be sure to use each sub-account to only pay bills designated by that category.
Profit First method FAQs
What is the Profit First 10/25 rule?
As part of the Profit First accounting method, Profit First author, Mike Michalowicz, recommends that business owners allocate funds from their revenue sub-account to other sub-accounts on the 10th and 25th of each month.
How do you calculate Profit First?
Profit First accounting is calculated with the formula “Revenue – Profit = Expenses.” This is in contrast to the traditional accounting formula “Revenue – Expenses = Profit.”
Does the Profit First method work?
Yes, the Profit First cash management method can help to increase revenue, improve financial management, and provide clarity for your business budget. However, Profit First accounting may not be a good fit if your business has thin profit margins or high debt, or your business checking provider doesn’t offer sub-accounts or automated transfer rules.
Easily set up your business checking account for Profit First with Bluevine.
