PROFIT FIRST
Revenue Is Vanity, Profit is Sanity, and Cash is King.
- Take profit first, then grow. You must figure out the things that make profit and dump the things that don't.
- When you focus on profit first, you inevitably figure out how to make profit consistently.
The Survival Trap
- “I want a lot of money and need relief from stress” will put you in survival mode. Many decisions we make in “just selling” takes us away from our true vision.
- The Survival Trap promises fast money, but when we’re caught in it, we rarely think of the cost of opportunity. This will distort your ability to tell the difference between profitable income and debt-generating income.
- Sustained profitability depends on efficiency. You can't become efficient in crisis.In crisis, you justify making money at any cost, including pulling from profit and tax reserves.
GAAP Accounting
- GAAP method: Sales - Expenses= Profit
- GAAP causes you to sell more due to the belief of Bigger Is Better- causing you to do anything you can to make top line (revenue) drip to the bottom line.
- GAAP teaches us to focus on Sales and Expenses first vs. Profit First. Our human nature urges us to grow what we focus on. “What gets measured, gets done”.
- Although you must avoid GAAP, you should be familiar with
- Cash Flow Statement
- Income Statement
- Balance Sheet
- To successfully run a profitable business, you must have a super simple system to manage your cash- one you can understand without help from an accountant.
Core Principles
When we use smaller plates for food, we dish out smaller portions, thus eating fewer calories while eating everything that is served. If the plate size of your Operating Accounting is reduced, you would spend differently. In Profit First, you create the experience of having less cash on hand and find a way to still make things work. Also, think 401k deductions- “Out Of Sight, Out Of Mind”
- Parkinson's Law: The more we have of something, the more we consume. The demand for something expands to match its supply (Induced Demand).
- Expanded roads to reduce traffic never works long term because more drivers show up to fill lanes.
- Your client gives you a week to turn around a project, you'd likely take the whole week. If she gives you a day, you'll make it happen in a day.
- When there’s less toothpaste in the tube, you consume less toothpaste.
- When you have less you: 1. Become frugal, 2. Become extremely innovative to make ends meet.
- Toothpaste Analogy: You need to intentionally make less toothpaste (money) available to brush your teeth (Business Operations).
- The Primacy Effect: We place additional significance on what we encounter first.
- When we follow the formula: Sales-Expenses=Profit, we are primed to focus on Sales and Expenses, and treat Profit as an afterthought.
- When profit comes first, it is the focus, and never forgotten.
- Temptation Removal: Out of Sight, Out of Mind.
- As you generate a profit, you must immediately remove it from access.
- You’ll find a way to work with what you have and not worry about what you don't.
- Rhythm Enforcement: Establishing a rhythm will relieve you of daily panic.
- Establishing a rhythm will be a great indicator of overall cash flow. This system is the easiest way to measure cash flow.
Chasing Growth
- Chasing growth for its own sake is how you wind up broke and out of business.
- Fastest, healthiest growth comes from businesses that prioritize profit.
- When you take profit first, your business will tell you immediately if you can afford the expenses you're incurring.
- If you find that you can't take bills after taking profit first, you must address it and fix it!
- You must do more of what is profitable, and dump what isn't.
- You must specialize vs being a generalist.(Heart Surgeon= $, General Practitioner= No $)
The New Accounting Formula: Sales - Profit = Expenses.
- Use Small Plates: Disperse all the money from your income account into different accounts in predetermined percentages. (Think Thanksgiving meal)
- Serve Sequentially: Always allocate money based upon the percentages account first. Never pay bills first. Pay bills with your OPEX account only.
- Remove Temptation: Move your PROFIT and TAX accounts out of reach.
- Enforce a Rhythm: Do your allocations and payables twice a month (10th and 25th).
- Accounting Setup
- Bank Balance Accounting: Logging into your bank account, making note of balances, and making decisions. Profit First is designed for bank balance accounting.
- Profit and Tax accounts (PROFIT HOLD/TAX HOLD) require no-temptation accounts at different banks. (Out of Sight, Out of Mind).
- Taking money from the PROFIT account and putting it back into the business is saying “You are unwilling to find a way to run your business with allocated OPEX”.
- Try your hardest not to be able to access the PROFIT HOLD and TAX HOLD online (maybe have the bank cut you a check instead?)
- You must allocate to each account on the 10th and 25th.
- Create a Biweekly Salary for yourself, and leave the rest in the account to accumulate.
Business Health: Instant Assessment Introduction:
- Profit First is a Cash Management System: Did you get the cash or not? Did you spend the cash or not?
- To conduct the Instant Assessment, you will need last year’s P&L, tax return, and annual balance sheet. Learn how these work!
- Personal Plan: Conduct this assessment quarterly
Instant Assessment Terms:
A1
- Top Line Revenue: Total Revenue from sales- top line on your P&L statement.
- Materials: For manufacturers, retailers, or if more than 25% of sales have been derived from the resale or assembly of inventory, the cost of materials (not labor) for the last 12 months. Not the same as Cost of Goods Sold. Materials only.
- Subs: If subcontractors deliver the majority of services, enter cost for past 12 months (subcontractors work on a project basis- your marketing project, engineers, product developers). They are not paid on payroll- but on project fees, commission, hourly rates, and they handle their taxes.
- If Material and Subs costs are less than 25 percent of Top Line, put $0 in cell A2.
- Real Revenue = Top Line Revenue - Material and Subs
- Real Revenue is the real money your company makes.
- Real Revenue is different from gross profit. Gross Profit = Top Line Revenue - Materials & Subs - Employee Labor
- Employee Labor would fall under business operations (VAs and VBMs)
- Now that you know your Real Revenue, start with Profit First.
- Actual profit from last 12 months that you have sitting in the bank or have distributed.
- Owners Comp: How much you’ve paid yourself in payroll distributions.
- Tax: How much taxes your company has paid.
- Operating Expenses= Total Expenses - Profit - Owners Comp - Tax - Materials & Subs.
- TAP [Target Allocation Percentage] (PF%)
- TAPs are NOT your starting point. They are targets to move toward!
- PF$: Profit First Profits- Your target ‘Profit First’ dollar amounts.
- Real Revenue x TAP= PF$
- Delta AKA The Bleed: The amount you need to make up.
- Negative means you're ‘bleeding’ money in this area- paying too little.
- Positive means you’re paying in excess- paying too much in this area.
- Actual - PF$ = The Bleed
- “The Fix” will return a value of either Increase or Decrease.
- A negative number in Delta or “The Bleed”= Increase
- A positive number in Delta or “The Bleed” = Decrease
Target Allocation Percentages:
- Less than $250,000 in Revenue: One employee (you) with some contractors or part timers.
- $250,000 - $500,000: Likely will have employees, and basic systems are necessary. OPEX will increase due to the need to pay employees. Owners comp will drop as you do less work.
- $500,000 - $1,000,000: More systems are created and more employees are added.
- $1,000,000 to $5,000,000: Systems are absolutely necessary- all knowledge in your head must be converted to systems, processes, and checklists. This is the hardest stage to produce growth. This is when you are focused on working on the business and selling big projects.
- $5,000,000 to $10,000,000: A management team and consulting firm is bought into the company. The majority of owner compensation is profit.
- $10,000,000 to $50,000,000: The company will stabilize and achieve predictable growth. The founder’s income is entirely made up of profit distributions.
No matter what the number is, if you work toward it and believe its a possibility, you will not only achieve it, you will plow past the numbers others have set.
- TAP Analogy: Going full throttle into Profit First is like donating 5 gallons of blood at once, you’d die. If you donated 5 gallons over time, you’d be fine.
- You always move forward with TAPs, NEVER backwards.
Your Most Important Employee:
- Your most important employee is you. You wouldnt cheat a hard working employee of fair wages, so why cheat yourself?
- Working on your business is about building Systems.
- Growing the company isn't an overnight switch from doing the work to handing it off. (It isn't like flipping a light switch- its gradual)
- As your annual growth grows past $500,000, you will transition into spending more time building systems.
- The goal of every business is health, and you should be able to do that through efficiency.
Tax TAP:
- The tax plate is designed to pay direct Tax Liabilities AND your personal taxes! You must let your company pay both.
- Its mandatory to talk to your accountant so she can advise you on all the ways your business will be taxed.
- If you come up short in taxes, your TAP was too low. This is the only time you can pull from your PROFIT account.
- Any left over taxes can be put into your PROFIT account once paid.
Profit Account:
- Monetary Reward for Equity Owners
- A Metric to measure growth
- Cash reserve for emergencies: Every distribution: 50% Profit, 50% Emergency Reserve
- Profit distribution can never go back to the company- only personal benefits!!
- Your business must run off of OPEX.
- Once your Emergency reserve has built up 3 months, you may use this back into your business or into a new business investment account.
Prepare For Your Worst Month:
- Until your best month becomes your average month, it is NOT the norm!
- When you base decisions on your best revenue month, you will run out of cash.
- If the money in Owners Comp is not enough to pay your salary, you can't take it.
- Owner Salary = 3 worst months average.
Debt Freeze:
- Cut the fat from your business- the stuff that isn't generating or supporting income for your income for your company.
- “Just one more day”- by waiting just one more day, you're not only keeping cash in your account for one more day, but you're giving yourself another day to come up with alternatives.
- The new definition of success is not about the most revenue or office space but the most profit generated through few employees and inexpensive office space.
- You cannot add new debt as you pay off old.
Efficiencies
Always Find Money Within Your Business:
How can I get two times the results with half the effort and cost?
- Money can always be found through streamlining and innovation, which begins with asking big questions. Impossible questions. The questions no one else will ask.
- If you want to crank up profitability, you must have efficiencies in place. Sales without efficiencies is disaster.
- 95% of your company’s profitability is contingent on what happens beneath the surface (after the sales).
Competition:
- When profit margins are big (>20%) the competition will sniff out what your are doing and begin to replicate what you're doing better, faster, and cheaper.
- You must find ways to keep doing what you are doing better, faster, and cheaper.
- When your prices drop due to competition, its time to innovate again.
Two Times The Results, Half The Effort:
- Focusing solely on top line thinking (sales, sales, sales) does not lead to profitability.
- Sales vs Efficiency= Think of trading a normal size toothpaste for 2 travel size.
- Efficiencies increase profit margins.
- You grow what you focus on: focus on substantially improving efficiency.
If you are struggling in business, don't find money to cover it! Find another solution!
Method: Achieve greater efficiency first, then sell more, then improve efficiencies even more and sell even more. Then, over time, speed up the back and forth between the two happen simultaneously.
Clientele
- Clients who complain about how much you charge and how much you suck but pay you in peanuts, and the ones who demand rework and never pay you or on time are costing you money!
- Pareto Principle: 20% of your clients yield %80 of your revenue! 80% of your profit is derived from 20% of the products or services you offer.
- Get rid of the clients who only want your least profitable products and services.
Sell Smart
- Avoid Upselling too much. By utilizing too much upselling, you are opening yourself up to the hassle of too many projects and acquiring to much equipment.
- Efficiency is the secret sauce of Profitability! (Getting more of the same things done with better and better results, using fewer and fewer resources).
- Sales without efficiency measures and systems only leads to larger expenses and fewer clients.
Advance Techniques
If you need to save for something: Add another account.
- The Vault: Ultra-Low Risk, interest-bearing account used for short term emergencies. The money built in the profit account for emergencies may not suffice, and money flow per quarter is unpredictable.
- You must establish rules for your Vault. What is your Vault Plan? Withdrawal Consequences?
- Stocking: Used for big purchases and inventory stocking.
- Pass-through: An account utilized for Contractors to pay customers directly.
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