Book Review: Profit First
Updated: Mar 17, 2020
Go to any online business forum and you’ll be hard pressed not to see someone recommending Profit First. This book has helped revolutionize the way I think about business finances and would be right up there on my list of top-small-business-owner-books. I know, I know, I say that for every book review I do... But seriously, this book has the capability to turn your business finances around. I know first hand, as I’ve implemented the profit first model at the software business I work for, and it is making a significant difference.
Profit First completely flips the traditional way a business owner looks at their financial picture. The traditional method is:
Profit First believes it should look like this:
Here's the secret of the entire book - and it’s not rocket science. You need to think about your PROFIT FIRST! Profit is the reason we are operating our businesses, right? So why do we think about it last?
You’ve heard it said that when you first start out you need to plow your profits back into your business so that you can grow. Mike Michalowicz, the author of Profit First, rejects that common belief and asks - why? He believes that you should take profit as you grow. Which is better… a business with a million in revenue and $50k in profit, or a business with $100k in revenue and also $50k in profit. I would argue that the smaller business, making the same amount of profit. Why? Because a bigger business typically means more stress & more responsibility. Whether it's more employees, more clients, more liability, more inventory, you name it - it all equals more difficulties. Why do we forget about our profit AS we grow our business? Maybe we think that “one day” we’ll eventually reach a point where we can generate massive profit. But, if that day never comes, you want to at least be able to pull out some profit as you go. According to Mike, successful businesses should be able to generate a profit from day one.
Enough big picture. Let's get down to brass tacks and discuss how to implement this model practically. Have you heard of the envelope method, used by personal finance guru Dave Ramsey? Basically, you budget out your expenses for the month (i.e. $100 for gas, $400 for groceries, $80 for utilities, etc) and separate out the cash in different envelopes for each category. When you go to the grocery store you take $100 out of that grocery category to use on your purchases. This makes certain that you will never go over budget because, when the envelope is out of cash, you’re done for the month. As cash dwindles in your envelopes, you become more frugal with your purchases to make it through the month. It is similar to the basic dieting idea that if you use a smaller plate, you end up eating less. Profit First uses this exact same method - but instead of using envelopes, we use bank accounts. Mike Michalowicz recommends setting up at least 5 accounts:
- Operating expense
- Owner taxes
- Owner compensation
Twice a month you allocate a certain percentage from your income account (all of the money paid to you for your services or product) to the other 4 accounts. For instance, if you had $100 in your income account you may allocate $5 to profit, $2.50 to taxes, $2.50 to compensation, & $90 to operating expenses. You will have $90 in your opex account to use for your upcoming expenses, until your next allocation. Over time you can try to decrease your expenses and increase the percentages you allocate to your other accounts. The book goes into significantly more detail but you get the general idea!
No doubt, this book takes a unique approach on how to handle your finances. This method may be more of an administrative burden; however, the psychology behind it is proven to work and with dedication and adherence to this framework, your business will be better off over time. Bottom line: read this book, implement the framework, & reap the benefits.
Michael Kern, CPA