If you’ve heard of Profit First before you may have heard people rave about it and how brilliant it is. But what is it actually all about and how does it work? In this post I’ll explain what Profit First is and how I’ve set it up for my business.
In a nutshell, it’s a fantastic method to manage money in your business – buy the book and get it set up for your business!
What is Profit First?
Profit First is just brilliant. It’s a method created by Mike Michalowicz who has also conveniently written it all down in his book, Profit First. If you are interested in using this method in your business I highly recommend you buy the book to set up Profit First fully. I’m not going to rehash it here because it’s all in the book. Here’s a quick summary though:
When you see that Chapter 1 of the book is called ‘Your business is an out-of-control cash-eating monster’ it will give you a bit of a clue what it’s all about!
Profit First turns traditional accounting on its head. Non Profit First businesses use the traditional method which is sales – expenses = profit. Profit First works differently:
Sales – profit = expenses
By taking the profit element out of the business first, if you have to be leaner because it seems there’s not enough money to run the business it forces you to find ways to save money but still create the same results. It makes you much more aware of what you’re spending and on what.
That’s not all though. The other key element of Profit First is not to keep all of the business’s money in one big pot. As Mike Michalowicz says “every penny my company made was going onto one huge plate, and I was gobbling it all up, using every last scrap to operate my business. Every dollar that came in went into one account, my operating account, and I was ‘eating it all’.
So instead of having one place to keep all of your money, ie a single business account, Profit First is all about dividing it up into separate pots and repeating that on a regular basis. By removing these chunks of money from your main income account, it’s out of sight, out of mind and temptation to spend it is removed.
When you set up Profit First there are recommended percentages to use for your allocations to each pot. These are likely to change over time and will vary from business to business. You may also start allocating, for example, a smaller percentage to Profit than you’d like to but you keep a note of your TAP – Target Allocation Percentage, which you can keep under review and work towards over time.
The order in which you allocate your money into the separate pots is important too. First, it’s Profit, then Owner’s Comp (which I’ve labelled as My Pay), Tax and then OPEX (operating expenses).
And as I said above, if there’s not enough left in OPEX, you don’t take money from the other accounts. You have to reduce some of the OPEX items going forward.
The aim is to get into a rhythm with this and Mike Michalowicz recommends doing it twice a month, on the 10th and the 25th.
“This is controlled recurring and frequent cash flow management, not by-the-seat-of-your-pants cash management”.
I had been using the by-the-seat-of-your-pants method for far too long. Since I’ve been using Profit First, which is only since April 2020, it’s been life changing. And I don’t say that lightly or in a cliched way. For the first time ever, in 10 years of running my own business, I pay myself every two weeks, I make a profit distribution to myself every quarter and I have money set aside for tax. Smug is almost the word. Sorry, not sorry.
My Profit First set up for my business
Note: I run my business as a sole trader and I’m not VAT registered. If you have a limited company and/or are VAT registered you’ll have to make a couple of adjustments – I’ll refer you back to the book for those!
I bank with Starling which is a brilliant bank anyway but having the ‘spaces’ feature makes it perfect for setting up Profit First. Spaces are like mini savings accounts so any money you put in those spaces (you can have as many as you need) does not count towards your main account balance.
- I use my Starling account for income and OPEX. So I haven’t split those two out into separate accounts (although this is recommended in the book).
- In my Starling spaces I have:
- My Pay
I also have a business account with Monzo and that’s where I have my Profit Hold and Tax Hold accounts. I make use of ‘pots’ in Monzo to keep those accounts separate and away from temptation. Pots in Monzo are very similar to Spaces in Starling.
Every 10th and 25th of the month I do the following:
- Go to Starling and look at the ‘spending’ tab. At the bottom is the Revenue category which I go into to note all of the income amounts for the two week period in question (so for 26th-10th or 11th-25th).
- I enter the total into a Google sheet which I’ve set up to automatically calculate the amounts that then need to be transferred to the My Pay, Profit and Tax spaces (based on the percentages that I’ve chosen to allocate to those accounts). I’m sharing my Profit First Tracker spreadsheet with you! Scroll down for details.
- Back in Starling again, I transfer the relevant amounts calculated by my Tracker spreadsheet into the three spaces for My Pay, Profit and Tax.
A day or so later, I transfer the full amount in the Tax and Profit spaces in Starling out and into the relevant pots for Tax Hold and Profit Hold in Monzo.
I also pay myself a set amount (as I’ve previously decided) from My Pay.
At the end of every quarter (ie 31 March, 30 June, 30 September and 31 December)
I distribute 50% of the total in the Profit Hold account to my personal account as a quarterly profit distribution.
Get my Profit First Tracker spreadsheet!
I’m sharing my Profit First Tracker with you so you can use it to set up Profit First in your own business. To get your copy add your details below. You’ll be added to my email list from which you can unsubscribe at any time.