Profit First

1. Take your profit first, not last

Sales − Profit = Expenses

Reverse the formula. Traditional accounting uses the formula Sales - Expenses = Profit, which often results in no profit at all. By taking profit first, you ensure your business is profitable from day one. This simple change forces you to innovate and become more efficient with fewer resources. It also aligns with human behavior, as we tend to manage what we see first.

Small, consistent actions. Start by allocating just 1% of your income to a separate profit account. Gradually increase this percentage over time. This builds the habit of prioritizing profit without putting too much strain on your business initially. The goal is to eventually reach industry-standard or above-average profit percentages.

Benefits of taking profit first:

• Ensures profitability from the start
• Forces efficiency and innovation
• Aligns with natural human behavior
• Builds a crucial habit through small, consistent actions

2. Use small plates to control portions and spending

When less money is available to run your business, you will find ways to get the same or better results with less.

Leverage Parkinson's Law. This principle states that work expands to fill the time available. Similarly, expenses expand to consume available resources. By artificially limiting your operating expenses, you force yourself to become more efficient and innovative.

Create scarcity. Just as using a smaller plate leads to consuming fewer calories, allocating less money to your operating expenses forces you to make do with less. This scarcity drives creativity and efficiency. You'll find ways to achieve the same or better results with fewer resources.

Strategies for creating artificial scarcity:

• Use separate bank accounts for different purposes
• Allocate funds based on predetermined percentages
• Remove temptation by making certain funds less accessible
• Regularly assess and adjust your allocation percentages

3. Implement the Profit First system with five core accounts

Profit is not an event. Profit is a habit.

Set up five foundational accounts. The core of the Profit First system involves creating separate bank accounts for different purposes:

1. Income
2. Profit
3. Owner's Compensation
4. Taxes
5. Operating Expenses

Follow the allocation rhythm. Twice a month, on the 10th and 25th, allocate funds from your Income account to the other accounts based on predetermined percentages. This creates a regular habit of prioritizing profit and managing cash flow.

Key steps for implementation:

1. Open the necessary bank accounts
2. Determine your initial allocation percentages
3. Start with small, manageable percentages
4. Consistently follow the twice-monthly allocation schedule
5. Gradually increase percentages over time

4. Assess your business health with the Instant Assessment

Profit First is designed to get you in the ballpark of where we are, and then tells us where we need to start going.

Conduct a financial health check. The Instant Assessment is a simple tool to quickly gauge your business's financial health. It compares your current allocation percentages to target percentages based on your revenue range. This provides a clear picture of where improvements are needed.

Use the results to guide improvements. The assessment highlights areas where you're overspending or underfunding. Use this information to set goals for gradually adjusting your allocation percentages to reach healthier targets.

Key components of the Instant Assessment:

• Real Revenue calculation
• Current allocation percentages
• Target allocation percentages
• Gap analysis between current and target percentages
• Action items for improvement

5. Gradually increase your profit allocation percentages

TAPs are not your starting point; TAPs are the targets you are moving toward.

Start small and build momentum. Begin with allocation percentages just slightly above your current levels. This makes the change manageable and builds the habit of prioritizing profit. Over time, gradually increase these percentages to move closer to your Target Allocation Percentages (TAPs).

Adjust quarterly. Every quarter, reassess your allocation percentages and increase them if possible. This steady progress allows your business to adapt and become more efficient over time, rather than attempting drastic changes all at once.

Guidelines for increasing allocation percentages:

• Aim for 1-3% increases per quarter
• Focus on the Profit, Owner's Compensation, and Tax accounts
• Reduce Operating Expenses to accommodate increases
• Adjust based on business performance and cash flow

6. Destroy debt while building profit

If you have debt, be it one thousand, one million or somewhere in between, you need to kill that debt once and for all while still slowly and methodically building profit.

Implement a Debt Freeze. Stop accumulating new debt immediately. Cut unnecessary expenses and negotiate better terms with creditors. This frees up cash flow to tackle existing debt.

Use the Debt Snowball method. List your debts from smallest to largest. Focus on paying off the smallest debt first while making minimum payments on others. As each debt is paid off, apply that payment to the next smallest debt. This creates momentum and motivation.

Strategies for debt reduction:

• Cut unnecessary expenses
• Negotiate with creditors for better terms
• Use 99% of profit distributions for debt repayment
• Celebrate small wins to maintain motivation
• Continue building the profit habit with the remaining 1%

7. Find hidden money within your business through efficiency

Money is everywhere.

Challenge assumptions. Regularly question every aspect of your business operations. Look for ways to achieve better results with fewer resources. This mindset of constant improvement can uncover significant savings and efficiency gains.

Focus on your core strengths. Identify the most profitable aspects of your business and double down on them. Eliminate or outsource activities that aren't core to your success. This allows you to maximize efficiency and profitability.

Areas to explore for hidden money:

• Streamline processes and systems
• Eliminate unprofitable products or services
• Optimize pricing strategies
• Improve employee productivity
• Reduce waste and unnecessary expenses
• Leverage technology for automation

8. Apply Profit First to your personal finances

The Profit First lifestyle is a frugal lifestyle, for sure. But the frugal lifestyle is not the same as a cheap lifestyle.

Create personal Profit First accounts. Apply the same principles to your personal finances by creating separate accounts for different purposes:

1. Income
2. Profit (savings/investments)
3. Taxes
4. Operating Expenses (bills and necessities)
5. Vault (emergency fund)

Live below your means. Allocate a portion of your income to savings and investments before determining your living expenses. This ensures you're building wealth and financial security while living a comfortable, but not extravagant, lifestyle.

Tips for personal Profit First implementation:

• Start with small allocation percentages
• Gradually increase savings over time
• Cut unnecessary personal expenses
• Celebrate milestones to stay motivated
• Teach children about money management using similar principles

9. Avoid common mistakes when implementing Profit First

The worst enemy of Profit First is you.

Stay accountable. Find an accountability partner or group to help you stay on track with your Profit First implementation. Regular check-ins and support can prevent backsliding into old habits.

Resist temptation. Avoid "borrowing" from your Profit or Tax accounts to cover operating expenses. This defeats the purpose of the system and can lead to financial trouble.

Common pitfalls to avoid:

• Taking too much profit too soon
• Focusing on growth at the expense of profit
• Cutting the wrong costs
• Adding unnecessary complexity to the system
• Skipping the separate bank accounts
• Raiding the Tax account
• Trying to manage it all through spreadsheets instead of actual bank accounts

Last updated: July 21, 2024