That’s my word of the year this year. Of course it applies to my personal life, but also to my businesses.
In the past, I have tried to read a certain amount of books each month to hit a yearly goal, but it has never worked out in the past. I always read two books in January, start a third in February, and never finish that one, let alone pick up another for the remainder of the year. Instead, this year I framed it differently. The books I read are meant to help me “nurture” my business, and that gives me a bit more motivation to keep reading, as opposed to hitting some arbitrary number of books read per year.
All this to say, one of the first books I picked up this year was Profit First. Profit First is all about how exactly to structure your bank accounts to turn your business into a profit-making machine. It’s a great read that I will suggest to every entrepreneur until the end of time. I don’t want to spoil it, but I do want to review some of Mike Michalowicz’s main points.
Essentially, boiled down to very simple terms (and perhaps I am oversimplifying), Parkinson’s Law is that you use the amount that you have. In terms of business, if you have $10,000 in your bank account for expenses, you will use $10,000 for expenses. If you have $2,000 in your bank account, you’ll use $2,000 for expenses and get the same, or possibly better, results. Another example he used in the book is a tube of toothpaste. You know how when you get down to the last little bit of toothpaste in the tube, you somehow make it last for much longer than the majority of the tube? Yep, just like that. When you only have a little, you make it last.
After understanding this law, you then begin to wonder—how do I make myself think I have less money than I do?
Well, he’s got an answer for that too.
Setting Up Your Bank Accounts
Like I mentioned, I don’t want to dive too deep into the content because I truly think you should read the entire book to fully understand the reason behind what you are doing. But simplified greatly, there are five accounts he advises you to have at your primary business banking institution:
- Income – All money that is deposited into your account goes here.
- Profit – A percentage of the income account is distributed into the profit account. More detail about profit will come later in this post!
- Owner’s Compensation – A percentage of the income account is distributed into the owner’s compensation account. This is what the owner of the business is paid from (one of the things I struggle with most as a business owner!).
- Taxes – A percentage of the income account is distributed to the tax account so that it is set aside for monthly and quarterly taxes.
- Operating Expenses – A percentage of the income account is distributed into the operating expenses account to pay your bills.
Each of these accounts serves a purpose within your business. The percentage of the “income” account that each of the other accounts receives is based off the size of your business and its “real revenue,” as he calls it. This will be different for every business, which is why it is so necessary to read the book in its entirety to be able to execute this system for your business!
Remember Parkinson’s Law we discussed before? This system basically allows you to only see what you have in the “Operating Expenses” account and THAT is what you have to run your business off of—not the total of all five accounts! That is one of the reasons this system is so effective. You are running your business effectively the same way as you would with a larger budget.
The title of the book is Profit First, so obviously profit plays a large part in the grand scheme of things as well. This is one of my favorite parts because who doesn’t want to receive a quarterly profit pay out?! Mike teaches that the profit account should serve two purposes:
- Simply that—profits. The difference between sales and expenses.
- A “rainy day fund” that will serve as a buffer if ever income stops totally. You will have a reserve for your business to be able to sustain itself for x amount of weeks or months.
Of that profit account though, each quarter, you are to reward yourself with 50% of the amount in the account. I mean, if that isn’t why we all became business owners, I don’t know what is. Having that type of reward is something I have never allowed myself to have before. And I am excited to see how it will continue to light the fire beneath me to make it continue!
Within Profit First, Mike also gives an outline for how to apply the same principles to your personal finances, which I found sort of helpful, but less helpful than the business application.
I will say that when Caleb and I first got married, at the end of each month I was always like, “Where did our money go?” So after about three years of that (and we had a baby on the way), we finally sat down and created a budget.
Essentially what Profit First personal version says is to create this budget and draw money out of each different account for different things (i.e. groceries, utilities, gas, etc.). For us, I think that would be a bit too difficult to keep up with, but to each their own!
Wow, that was a bit longer than my usual blog posts, but let me leave you with this:
It’s great to know exactly where the money in your business goes.
You should be paying yourself.
The quarterly profit allocations provide incentive and motivation even in the hardest of business times, which I think is why this system works.
If you’ve read the book and/or enacted the principles within it, I would be really interested to hear your reactions and experiences. Please leave a comment below!
If you haven’t read this one, 10/10 would recommend from now until eternity.