The Profit First method is a new approach to cash flow management that’s helping entrepreneurs ensure they make a profit and are paid. As intuitive as that might sound, entrepreneurs are typically terrible at paying themselves fairly or promptly. It doesn’t have to be this way.
Introduced in Mike Michalowicz’ book, Profit First, this method is winning praise from accountants, small business owners, and the financial independence community for reframing ideas about budgeting and cash flow. Through effective storytelling and practical advice, Michalowicz has helped hundreds of thousands of readers take control of their business and personal finances.
If you’re looking to apply the tactics from Profit First into your own business, This Bank can help. Envelopes, a feature to designate purposes for funds like payroll or rent are perfect for opening the 5 Profit First accounts Michalowicz encourages Profit First entrepreneurs to open to distribute income.
(Business must be in Washington State)
What is the Profit First Method?
The Profit First method is a system in which business owners take a percentage from each sale as profit. The traditional profit formula deducts expenses from sales, leaving the remaining amount as profit.
The Profit First formula flips the script on how business owners typically think about accounting and budgets. Traditionally business owners deduct expenses from sales and consider the remaining amount profit.
Traditional Profit formula:
Sales – Expenses = Profit
The Profit First formula puts profit first and encourages you to deduct profit from each sale and use the remaining amount for expenses.
The Profit First formula:
Sales – Profit = Expenses
From the start, you’re accounting for your profit, taxes, and pay. What’s leftover is the budget your company has to spend on things like rent, salaries, material costs, and utilities.
It can be a bit uncomfortable to run your business this way. But putting profit first makes you more conscious of where and how you’re spending money.
More importantly, it makes you conscious of the need to invest in your own peace of mind and quality of life. That shift in mentality can be a game-changer for those not used to actually paying themselves.
How Does Profit First Work?
In Profit First, business owners take their profit out of the cash deposits before expenses rather than paying themselves with what’s leftover. The system involves transferring predetermined percentages of your cash deposits into various bank accounts to cover profits, taxes, operating costs, owner’s payments, and revenue.
How much you put into each account is determined by Target Allocation Percentages (TAPS). Your Current Allocation Percentages (CAPS) is how your Real Revenue is currently being spent.
The next section will cover these Profit First percentages and how to apply them to your business.
What are Profit First Percentages?
Profit First percentages provide insight into your business’ current financials and a process for accomplishing future financial goals.
Current Allocation Percentages (CAPS) help you understand how your financials are currently being allocated between income, owners compensation, operating expenses (OpEx), profit, and taxes.
Target Allocation Percentages (TAPS) are where you’d like your financials to be split in order to increase profitability, cash flow, and business growth. These percentages are where you’d like to grow your business from your current allocation percentages.
This chart by Mike Michalowicz helps you understand what your target allocations should be based on your business’ real revenue range.
You can read more about how you should determine your TAPS — including a helpful formula based on your state’s taxes here.
What are the 5 Profit First Accounts?
The 5 Profit First Accounts are Income, Owners Compensation, Operating Expenses (OpEx), Profit, and Tax. These are the different accounts you should open to track your TAPs and distribute funds.
When opening bank accounts for your Profit First business, you should open three checking accounts for Income, Owners Compensation, and Operating Expenses. Two saving accounts should be created for Profit and Tax.
Proceeds from sales should be deposited into your primary Income account then distributed into your other accounts based on the percentages you’ve allotted for each destination.
Choosing a bank which supports Profit First is vital for the success of your business’ use of the Profit First method. You should choose a business bank which doesn’t charge minimum balance fees and which allows the creation of multiple accounts at no additional cost.
You should also choose a business bank that reduces the hassle involved in managing money across 5 accounts. You don’t want to find yourself spending hours each week having to stay on hold with your bank or visit branches when all you’re trying to do is pay yourself first!
As the next section will cover, This Bank supports Profit First entrepreneurs, doesn’t charge minimum balance fees, and offers the creation of sub accounts for each of the five accounts you’ll need as a Profit First entrepreneur.
(Business must be in Washington State)