I recently had the privilege of reading Mike Michalowicz’s book Profit First and want to provide a review. Please know this is strictly my opinion and does not constitute accounting or legal advice. Consolidating a 191 page book into a succinct blog post is no easy feat. But I’ll try my hardest.
Sales - Profit = Expenses
Mike Michalowicz is really turning GAAP, or generally accepted accounting principles, upside down. The above formula is a stark contrast to the formula Sales - Expenses = Profit (as you will find in traditional accounting classes). I have to agree that planning to profit first -- making this required mental shift -- is crucial to the survival and growth of your business. I see far too many business owners with wonderful ideas or products, but they never pay themselves for the hard work and toil. Entrepreneurship can be glitzy and glamorous to outsiders but requires far more dedication and persistence than meets the eye.
The Survival Trap
Do you feel stuck in survival mode? Do you feel a constant sense of crisis? Covering payroll, hiring outside experts, generating quick cash, being a slave to work …. All of these things are certain to weigh down any business owner. There is often a disconnect between the current state and the vision of where you want to be. Moving outside the survival trap requires clarity around the vision. The goal is not to offer every product or service under the sun but to specialize and utilize your strengths. Survival mode is just the opposite … you keep bad clients or offer too many services that are not aligned with the company’s core vision, all in an effort to increase revenue. You’re on the hamster wheel that doesn’t end!
Start with a Clean Slate
Make the decision today to start fresh. Don’t beat yourself up over mistakes or look at historical business financials as your destiny. One of my clients asked me to prepare five-year forward looking projections for her business. Her company has been losing money for a couple of years. Do I just give up on her and tell her she needs to fold? NO. She’s not going to be a victim of circumstance; instead, we will create projections based on increased sales. This is a critical juncture: she knows she needs to either GO BIG or GO HOME. I’m doing everything in my power to help her go big, and the principles in this book are laying that foundation.
Keys to Healthy Growth
Scaling too quick can be detrimental to your business. Fixed costs ramp up quickly, and it is hard to let employees go if sales are unsustainable. Profit First looks at a healthy diet and applies that to company financials:
Small Plates - As soon as revenue comes into your business’ main operating account, immediately transfer money into four separate accounts: Profit, Owner Pay, Tax, and Operating Expense. Follow the predetermined target percentages below (see the Instant Assessment section) and use automatic bank transfers to your advantage.
Serve Sequentially - ALWAYS move funds into your Profit account first, and then fund the Owner Pay, Tax, and Operating Expense accounts. If there isn’t enough money to put in the expense account, find a way to cut expenses. Don’t steal from Paul to pay Peter.
Remove Temptation - Guard the four accounts and put an accountability mechanism in place so you are never tempted to take money away from the Profit account.
Enforce a Rhythm - Michalowicz suggests a recurring payable system, twice monthly, on the 10th and 25th.
Profit First Assessment
This is the meat of the book and the naked truth. Look at your actual figures for the last 12 months -- top line revenue minus materials (not labor) and subcontractor costs to arrive at Real Revenue. Then, apply the broad Target Allocation Percentages. For real revenues up to $250K, set aside 5% for Profit, 50% for Owner Pay, 15% for Taxes, and 30% for operating expenses. For real revenues between $250K and $500K, the suggested percentages are slightly different. 10% should go to Profit, 35% to Owner Pay, 15% to Taxes, and 40% to operating expenses. If you are above these thresholds, please go buy the book. Page 48 provides Target Allocation Percentages for real revenue up to $50M.
After going through this exercise, you will see very quickly where you are at and where you need to be. It’s at this point of revelation that many struggling businesses want to throw the book away. Michalowicz’s suggestion? Stop and come back to Profit First when you are ready to transform your business.
If you want to profit first but are confused by some of the concepts, I encourage you to buy the book and/or visit the resources section of Mike’s website. After the instant assessment, Michalowicz goes into a lot of detail on tax structure, target allocation percentages, and advanced techniques. It’s at this point of the book that someone can get lost in the minutiae and end up with 20 different accounts -- each for different operating expenses. I like to keep things simple and suggest the four main accounts: Profit, Owners Pay, Tax, and Operating Expense. Be sure to check out Chapter 10, which covers the Profit First lifestyle and has catchy titles like Death to Debt.
Along with Michaelowicz’s other books like The Toilet Paper Entrepreneur, Profit First is a good read for any entrepreneur who wants to transform the business from a cash-eating monster to a money-making machine.
Although I won’t be seeking certification as a Profit First Professional anytime soon, I appreciate the concepts in this book and look forward to applying them to client engagements. If you are interested in learning more about how my firm, SV CPA Services, can move your business forward, please reach out. Here's how to find me.
All the best,
Deborah Meyer, CPA, CFP(R)