For many people, opening a small business or starting work on their own is a way to achieve economic independence. Unfortunately, however, many businesses struggle to generate a real profit, being trapped in a continuous succession of deadlines and moments of endless crisis.
Trying to grow a business that does not generate profit and that consumes all our resources only risks generating a money-eating monster.
Using traditional accounting systems, which we are all used to, we learn that profit is whatever remains after ordinary management. Leaving profit as a last step, however, we fall into a trap: that of survival.
The good news is, it doesn’t have to be that way. If we decide to change the formula, we can immediately take a part of our revenues, our profit. All that remains will cover the expenses. And we can start immediately.
The basic principles of the Profit First method
The Profit First method aims to revolutionize our way of conceiving the accounting management of our business, creating a system that finally allows us to achieve the long-awaited economic independence, and to no longer be slaves to our business.
In some ways, the Profit First system is similar to a proper diet. The same principles that can help us adopt a healthier diet can help us restore our business to health.
Why use “smaller dishes”
When our revenues increase, we are led to increase expenses. A profitable period often leads us to be too optimistic, increasing expenses, often with a view to making our business grow. The more money we have, the less problems we have to approve new purchases, even when they are not needed. Who among us hasn’t taken some whim after finishing a big sale?
A tip that is often given to those who want to lose weight is to reduce the size of the dishes they use. In doing so, it will automatically be brought to serve smaller portions, without the mind feeling a lack of respect than usual.
Applying the same philosophy to our business, the idea is to not keep a single account in which to bring together all revenues and from which to scale all expenses. Dividing our accounting management into different current accounts is the first step towards a more efficient management system.
The first step is to immediately create an account to be dedicated exclusively to profit. This account must be absolutely distinct from the main one, and will receive our share of profit. In no case (except one that we will see later) will we be able to withdraw from here to cover business expenses.
We start immediately to transfer 1% of our income to this account. If we receive a payment of 1000 €, we pay 10 to the Profit account . After all, if we can keep the business going with 1000 €, we can also do it with 990. It might seem little, but that little money will begin to show us that it is possible to make a profit.
Over time, as our business becomes more optimized, the percentage of our profit will go up, but it is important to start immediately.
Make sure you always have a profit
Another tip that often accompanies diets is to eat those foods that are rich in nutrients, such as vegetables first. Similarly, the nutrients of our business are represented by our profit.
By putting profit first, we turn it into a certainty we can count on, rather than letting it be an eventuality that “could” happen, but rarely does.
If our first step is to put our profit aside, we will automatically be led to manage our business with what remains, making decisions based on what we can actually afford.
Often, this will lead us to downsize the business, but this is a fundamental step to create a business that is not only profitable, but also sustainable and efficient.
Remove the temptations
If our goal is to eat healthier, eliminating sweets and junk foods is definitely a good method. If we don’t have something available, we are much less inclined to give in to temptation. When something is at hand, it becomes difficult to resist, and we are much more inclined to commit some rudeness.
According to this principle, in addition to the Profit account , we can create different accounts for each expense we face. Ideally, each type of expense will have its own dedicated account, where we transfer a percentage of each revenue.
There are five accounts that we should open to follow the Profit First model :
1. Income: this is the account into which all income will flow. Twice a month, on fixed and set days, we will transfer money from this account to others.
2. Profit: where to pay what we decide to take as profit. It is the first account to pay into, and it must not be used to cover management costs. This account can also function as a reserve, so it is a good idea to never withdraw the full amount available. To be prepared for the worst, an excellent strategy is to make sure that there are sufficient funds in this account to guarantee three months of running the business even without revenue.
3. Compensation: the account from which our salary will be deducted. It is necessary to specify that income and profit are two different things. Income is what we receive in exchange for our work. Profit is what we receive as business owners .
4. Taxes: here we will set aside the part of revenue that will be subsequently paid in taxes. Failing to pay your taxes is one of the worst situations we can find ourselves in, so we always have to make sure we are covered. This is the only account that can afford to tap into the Profit account .
5. Operating Expenses: the account from which we will make all payments relating to the management of the activity. This account represents the financial availability that we have for our business. Using a dedicated account, we will enter the perspective of spending only what we can really afford.
Each of these accounts must be strictly used only for its intended purpose (except in the case of taxes), otherwise we risk falling into the survival trap again, frustrating all the work done so far.
It is important to set a pace to follow
Running a business is not a simple thing. There are a myriad of commitments, deadlines, projects that take up most of our time. Precisely for this reason it is important to establish a rhythm to follow for the management of our accounting.
Depending on the type of business we manage, our income will be more or less regular. Thinking about finding the time to allocate the right percentages every time we receive a payment could become problematic. The best approach is to choose 2 days a month, for example 10 and 25, to carry out this type of operation.
In doing so, we will have fixed dates on our calendar and we will be much more inclined to respect them. In the long run, this can also help us better understand the pace of our business, understanding how the market in which we operate works, and providing us with useful information to improve our business.
Evaluate your starting situation
Before embarking on this new method, it is good to make an assessment of our business. Only by understanding our current situation will we be able to determine how to distribute our income.
This evaluation aims to establish what percentages should be used for the distribution of revenue. Some values will be fixed and immutable, such as taxes. Others will depend on the type of business, our expectations, how business is going.
It is important to remember that the percentage to be dedicated to profits will be the lowest, at least during the initial phase, but that will grow over time. The greater the part of profit we can get, the healthier our business will be.
The Profit First method can help us with debt
Debts are a sore point for any business, and are often the cause of bankruptcies and closures.
Often, when we start to see an increase in revenue, we are led to make purchases, to try to grow our business. Whether it’s buying more material, or subscribing to subscriptions, all this contributes to making our expenses, and consequently our debts, increase.
The problem is that revenue increases are not constant, and often represent exceptions. If we set up our management based on two or three months of good sales, we are operating in an unsustainable regime.
A fundamental part of the Profit First method concerns the reduction of recurring expenses and debts. Here are some useful tips to follow:
- Search for a free alternative – Does our business require specialized software? There are probably free versions that can give us the same functionality.
- Evaluate the purchase of used material – Used equipment can often give us the same performance as a new object, but at a much more affordable price.
- Price negotiation – Especially in the business environment, most prices have a negotiation margin. We try to exploit it to reduce our costs.
- Delay large purchases – When possible, we avoid buying something expensive right away, trying to evaluate at least 3-4 alternatives that could bring the same benefits.
When to take profits and celebrate
An important consideration to make is how we access our profits. Setting aside our share of money doesn’t mean it’s a good idea to use it right away, or use it all.
A good habit is definitely to have regular deadlines in which to withdraw money from our Profit account in order to use it.
The ideal is to use a quarterly basis. This allows enough time to elapse between withdrawals not to turn them into an event we rely on, but not enough to wipe out the excitement ahead of the next withdrawal.
It is important to remember that profit is our reward as owners of our business, so we use that money to spoil ourselves, to go on vacation, to buy something that we have always wanted. Only in this way can we say that we are no longer slaves to our business.