Profit First by Mike Michalowicz Flashcards
(208 cards)
1
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the essence of financial security: save your money and block access to it so it doesn’t get stolen—by you.191
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Profit First by Mike Michalowicz
2
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as revenue increased, so did my spending.231
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Money problems occur when one of two things happen: 1. Sales slow down. The problem here is obvious—when we operate check-to -check and sales slow down, we don’t have enough to cover expenses. 2. Sales speed up. This problem here is not obvious, but it is insidious. As our income climbs, expenses quickly follow. Consistent incoming cash flow is hard to sustain. Big deposits feel great, but are irregular. Drought periods come quickly and unexpectedly, causing a major gap in cash flow. And cutting back on expenses is nearly impossible because our business (and personal) lifestyle is locked in at our new level.236
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4
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it’s rare to find a truly profitable business. Most entrepreneurs are just covering their monthly nut (or worse) and accumulating massive debt. We think bigger is better, but so often all we get with a bigger business are bigger problems.247
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5
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Simply put, the Profit First system flips the accounting formula.
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To date, entrepreneurs, CEOS, freelancers, everyone in nearly every type of business has been using the “sell, pay expenses, and see what’s left over” method of profit creation. This ingrained belief has us sell first, then pay expenses, and let the profit take care of itself. Which it rarely does, because the profit is what’s left over. An afterthought. Profit surely isn’t baked into the daily operations. For many entrepreneurs profit is only considered after the fact.256
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The old, been-around-forever, profitless formula is: Sales – Expenses = Profit The new, Profit First Formula is: Sales – Profit = Expenses261
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Profit First speaks to human behavior—it accounts for the regular Joes of the world, like me, who have a tendency to spend all of whatever is available to us.264
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Most business owners try to grow their way out of their problems, hinging salvation on the next big sale314
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10
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We default to managing the cash of our business by doing what I call “bank balance accounting.”335
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If you look at your bank account daily, I want to congratulate you, because that means you are a typical—scratch that—a normal business leader; that’s how most entrepreneurs behave.345
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12
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It’s human nature to look at what you have right now and make decisions based on that information. This is called the “Recency Effect,” the psychological phenomenon in which we humans (that’s you, by the way) place a disproportionate significance on what we experienced most recently.347
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13
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The Survival Trap promises fast wealth, but when we’re caught in it we rarely think about the massive cost of opportunity; and most of the time, we can’t discern profitable income from debt-generating income.388
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14
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The Survival Trap is not about driving toward our vision. It is all about taking action, any action, to get out of crisis.392
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15
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when we’re stuck in the Survival Trap, we focus our attention on revenue generation first and foremost. Any client (who pays) is a good client. Any work (that makes money) is good work.407
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16
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Never forget: All revenue is not the same. Some revenue costs you significantly more in time and money; some costs you less.409
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The Survival Trap is an ugly beast. It buys you time, but the monster gets bigger and bigger. And at some point it will destroy you.430
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18
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GAAP (Generally Accepted Accounting Principles). GAAP IS KILLING YOUR BUSINESS438
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19
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Logically, GAAP makes complete sense. It suggests that we sell as much as we can, spend as little as we can and pocket the difference. But humans aren’t logical.452
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20
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Just because GAAP makes logical sense doesn’t mean it makes “human sense.” GAAP both supersedes our natural behavior and makes us believe bigger is better. So we try to sell more. We try, and try, and try to sell our way to success. We do everything we can to make the top line (revenue) grow so that something, anything, will drip down to the bottom line.453
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21
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GAAP’s fundamental flaw is, it goes against human nature. No matter how much income we generate, we will always find a way to spend it—all of it.466
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22
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A secondary flaw is this: GAAP teaches us to focus on sales and expenses first. Once again, it works against our human nature, which urges us to grow what we focus on.472
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23
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There is a saying: “What gets measured, gets done.” GAAP has us measure sales first (it is the top line, after all), and therefore we sell like mad while expenses are treated like a necessary evil to support— you guessed it—more sales.474
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24
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Profit? Your salary? Mere afterthoughts. Leftovers.477
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And his first fix suggestion? Smaller plates.534
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rather than work to change our “eat everything on the plate” behavior we simply need to change the size of our plates. When we use smaller plates, we dish out smaller portions, thus eating fewer calories while continuing our natural human behavior of serving a full plate and eating all of what is served.540
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The solution is not to try to change our ingrained habits, which is really hard to pull off and nearly impossible to sustain; but instead to change the structure around us and leverage those habits.543
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Every penny my company made was going onto one plate, and I was gobbling it all up, using every last scrap to operate my business. Every dollar that came in went into one account, my operating account, and I was “eating it all.”545
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I was frugal in my businesses because it was forced upon me.548
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After losing it all, I discovered that I work with whatever is put in front of me. Give me a hundred dollars and I will make it happen. Give me a hundred grand and I will make it happen.554
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As my incoming cash increased (the darker line on Figure 2), my expenses increased at a similar rate (lighter line). The only time I would have a profit was when income jumped up and I didn’t have time to spend at the same rate. However, I would quickly ramp up my expenses to serve my “new level of sales.” Then sales would settle back down, or drop, while my new level of expenses remained higher. Losses accumulated. The desperate need to sell more, faster, increased.560
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“If I reduce the ‘plate size’ of my business’s operating account, will I spend differently?” Looking back at my past behavior, the answer came quickly. Yes, I would.564
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4 principles of weight loss /financial health 1. Use Small Plates – Using smaller plates starts a chain reaction. When you use a small plate, you get smaller portions, which means you take in fewer calories. When you take in fewer calories than you normally would, you start to lose weight.
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4 principles of weight loss /financial health 2. Serve Sequentially – Eat the vegetables, rich in nutrients and vitamins, first. If you leave them to eat last, you will rarely finish your vegetables. They’ll just sit there piled up on the side of the plate.
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4 principles of weight loss /financial health 3. Remove Temptation – Remove any temptation from where you eat. People are driven by convenience. If when you’re hungry, junk food is easily accessible, you’re more likely to eat it. If you don’t have any junk food in the house, you’re probably not going to run out to the store to get it. (That would mean putting on pants.) You’re going to eat the healthy food you stocked, instead.583
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4 principles of weight loss /financial health 4. Enforce a Rhythm – Don’t eat when you’re hungry; it is already too late, and you will binge. Instead, eat frequently so that you never get hungry. You will actually consume fewer calories this way.595
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Profit First is a simple, “small plate” diet philosophy.597
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1. Use Small Plates – When money comes into your main operating account, immediately disperse it into different accounts in predetermined percentages. Each of these accounts has a different objective: one is for profit, one for owner pay, another for taxes and another for operating expenses. These are the four basic accounts and where you should get started,605
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2. Serve Sequentially – Always, always move money to your Profit Account first, then to your Owner Pay Account and then to your Tax Account, with what remains to expenses. Always in that order. No exceptions. Move it, stash it and let it accumulate. And if there isn’t enough money left for expenses? This does not mean you need to pull from the other accounts. What it does mean is, you can’t afford those expenses and need to get rid of them. This will bring more health to your business than you can ever imagine.609
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3. Remove Temptation – Move your Profit Account and other accounts out of arm’s reach. Make it really hard and painful to get to that money, thereby removing the temptation to “borrow” (i.e., steal) from yourself. Use an accountability mechanism to prevent access, except for the right reason. 4. Enforce A Rhythm – Do your payables twice a month (specifically, on the 10th and 25th). Don’t pay only when money is piled up in the account. Get into a rhythm of paying bills twice a month so you can see how cash accumulates and where the money really goes. This is controlled, recurring and frequent cash flow management, not by-the-seat-of-your-pants cash management.614
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Step 1: Set up the small plates with your bank. You will need four accounts: Profit Account, Owner’s Pay Account, Tax Account and Operating Expenses Account. You probably already have one or two accounts with your bank (checking and savings). Keep the checking account as your Operating Expenses Account and set up Tax and Profit as savings accounts (these are simply holding bins), with Owner’s Pay as another checking account.640
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Some banks charge fees or have minimum balance requirements. Don’t let that deter you. Speak to the bank manager and negotiate the fees and requirements. If the manager is unwilling to negotiate, find a new bank.646
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Step 2: Set up two more external savings accounts with a bank other than the bank you use for daily operations. One account will be your no-temptation Profit Account. The second will be your no-temptation Tax Account. Set them up with the ability to withdraw money directly from the respective savings accounts in your original bank.648
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Step 3: Don’t enable any of the “convenience” options for your two external accounts. You don’t need or want to view these accounts online. You don’t want checkbooks for these accounts. You just want to deposit your income and forget it… for now.650
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The Pumpkin Plan, I stand by my method for growing niche-dominating businesses that lead to giant success.692
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replace that tired old misguided question about size and replace it with this one: “How healthy is your business?”698
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If you spend one more second worrying about the size of your business while compromising a strong bottom line, your business is unhealthy at best.701
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How healthy is your business? Are you eating first, or are you surviving on leftovers, or worse— scraps from the garbage can in the alley?705
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Figure 3 is the Profit First Instant Assessment form. Complete the form right now! You can write right in this book716
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1. In the Actual column, enter your Top Line Revenue for the last twelve full months.718
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2. If you are a manufacturer or retailer, or if most of your sales are derived from the resale or assembly of inventory, put the cost of materials (not labor) for the last twelve full months in the Material & Subs cell.721
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3. If subcontractors deliver most of your services, put the cost of the subcontractors for these twelve months in the Material & Subs cell. (Subcontractors are people who work for you, but have the ability to work autonomously and to work for others.723
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4. If you are a service company and most of your services are provided by your employees (you included), put an n/a symbol in the Material & Subs section.728
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5. Now subtract your Material & Subs number from your Top Line Revenue to calculate your Real Revenue. If you put an n/a in the Material & Subs section, just copy the Top Line Revenue number to the Real Revenue cell.730
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6. The goal is to get you to your Real Revenue number. This is the real money your company makes.731
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Real Revenue is different from Gross Profit, in that Real Revenue is your Total Revenue minus materials and subcontractors used to create and deliver the service or product. Gross Profit is Total Revenue minus materials, subcontractors and any of your employee’s time used to create and deliver the service or product. It is a subtle difference but a critically important one. Gross Profit includes a portion of your employees’ time. But the thing is this: You will generally pay your employees for their time whether you have a bad sales day or a good one.738
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7. Now that we know your Real Revenue, write down your actual profit from the last twelve months in the Profit cell. This is the cumulative profit you have sitting in the bank, or have distributed to yourself (and/or partners) as a bonus on top of—but not to supplement—your salary. If you think you have a profit but it is not in the bank and was never distributed to you as a bonus, this means you don’t really have a profit. (If it turns out that you have less profit than you thought you would, it’s likely you used it to pay down debt from previous years.744
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8. In the Owner’s Pay cell, put down how much you paid yourself (and any other owners of the business) these past twelve months in regular payroll distributions, not profit distributions.749
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9. In the Tax cell, put down how much money you have paid in taxes over the last twelve months, plus any money you have already reserved for taxes.750
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10. In the Operating Expenses cell, add up the total expenses you paid for the last twelve months—everything except your profits, owner’s pay, taxes and any materials and subs that you have already accounted for.752
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11. Double-check your work by adding up your profit, owner’s pay, taxes and operating expenses to see if you get your Real Revenue number.754
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12. Next, enter the profit percentage in the PF % column based upon your Real Revenue Range.757
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13. In the PF $ column, copy the Real Revenue number from your actual column. Then multiply that Real Revenue number by the PF % for each row and write down the number in the corresponding PF $ cell. These are your target PF dollar amounts for each category. Welcome to the moment of truth. (I hope we can still be friends.)761
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14. In the Bleed column, take your Actual number and subtract the PF $ number. This is very likely to result in a negative number. It is your bleed, the amount you need to make up. Negative means you are bleeding out money in these sections. Sometimes it is in just one category with a problem, but in most cases businesses are bleeding out in the Profit, Owner’s Pay and Tax Accounts and have a positive number (meaning excess) in Operating Expenses. In other words, we are paying too little in profit, owner salaries, and taxes, and paying too much in operating expenses.765
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15. In the final column, The Fix, put either “increase” or “decrease” next to each category. If the number in the Bleed section is a negative number, put “increase” in the corresponding Fix cell, because we need to increase our contribution to this category to correct the Bleed. Conversely, if it is a positive number in the Bleed section, put “decrease” in the Fix cell, since this is a category where we need to spend less money in order to fix it.769
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(More taxes, as painful as they are to pay, are a sign of a healthy business—the778
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A financially healthy company is a result of a series of small daily financial wins, not one big moment. Profitability isn’t an event; it’s a habit.785
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I use the phrase “top line” thinking, which is when you focus on revenue, revenue first and foremost, with profit as an afterthought. Top line thinking is dangerous because numbers are relative.790
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for so many businesses, the growth from $1M to $5M is the hardest.809
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At $5M to $10M, typically a management team enters a company to bring it to the next stage, and a clear second tier of management starts to form. The founder starts more and more to focus on her special strengths. The owner is on a consistent payroll, and the majority of her take home income is from the profitability of the company, not the salary she takes.815
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At $10M to $50M, a business will often stabilize and achieve predictable growth. The founder’s income is almost entirely made up of profit distributions. Owners’817
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Then I realized—duh. It wasn’t how much I was spending on expense line items. The problem was, I shouldn’t have been spending anything on some of those line items.832
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First, some entrepreneurs make the mistake of getting trapped in the details, spending hours, days, weeks or longer perfecting their percentages before they do anything. Worse, some entrepreneurs who get stuck in the minutiae never get around to doing anything.905
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On the other hand, if you’re like me, you might make the common mistake of taking action too big and too fast.910
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your Profit Account will fund your profit distributions and serve as your rainy day fund, you’ll want your Profit Percentage to grow past five percent quickly. If you save five percent of your company’s annual income, for example, that represents about twenty-one days of operating cash,953
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1. 5% profit allocation = 3 weeks of operating cash 2. 12% profit allocation= 2 months of operating cash 3. 24% profit allocation = 5 months of operating cash.960
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Owner’s Pay is the amount you and the other equity owners take in pay for the work you do.974
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Your salary should be on par with the going rate for the work you do, in other words—the salary you would have to pay your replacement.976
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owner’s pay should represent the work you do.1004
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Working on the business does not mean hiring a bunch of people to do the work and then spending all the livelong day answering their never-ending questions about how to do the job (the job you used to do). Shifting to a managerial role just means you are working in your business in a different way—and1017
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Working on your business is about building systems. Period.1020
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An entrepreneur is someone who finds the solutions to opportunities and problems and then builds systems to consistently deliver those solutions through other people or things.1020
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The transition from working in the business to working on the business happens over time—slowly, deliberately, one small step followed by another small step.1023
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As your annual revenue grows past $500,000, you will transition to spending more time building systems. Now, you’re a systems developer 20% of the time, a manager 10% of the time and an employee 70% of the time.1034
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As annual revenue grows past one million, your salary percentage will drop even farther because you will be working less and less in the business and more and more on the business.1037
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The bottom line is this: Don’t cut your salary to make the numbers work. The goal of every business is health, and that is achieved through efficiency. Your martyr syndrome is not doing anyone any favors; making yourself the sacrificial lamb does not promote efficiency, it hinders it.1045
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The first step in getting to your Tax TAP is to determine your income tax rate.1050
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One goal of the Profit First system is that the company takes care of all forms of tax responsibility.1058
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But hold on: If the tax rate is 35%, why would I only reserve 15% for taxes (as noted in the Instant Assessment I shared earlier)? Let’s do a little simple math. A LITTLE SIMPLE MATH Now we are going to determine the percentage that stays in your Operating Expenses Account, after you move money to your Profit Account, your Owner’s Pay Account and your Tax Account. The amount left over for expenses is likely going to be somewhere between 40% and 60%. This is the money you have available to pay all your expenses. Next, subtract that percentage from 100%. So, if your total Operating Expenses Account is at 55%, you’re left with 45%. That 45% is the amount you will be taxed on. (More often than not, expenses are not taxed. This is why some accountants encourage you to buy equipment or make other large purchases toward the end of the year.) Now, multiply your non- operating percentage (in this case, 45%) with your taxable income percentage (in this case, 35%). You end up with a percentage of approximately 16%, which is your Tax percentage.1084
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An up-and-coming motivational speaker went to a speaking boot camp. During one of the sessions, the instructor explained how to make back-of-the-room sales. He said, “When you follow this method, eighty percent of the audience will buy your product at the end of an event.” With pages of notes and tons of enthusiasm, our up-and- comer set forth on the speaking circuit. Initially, she closed only 25% of her audiences. Reaching for that 80%, she tweaked and improved her strategy and pitch, constantly reviewing her notes. Over time her close rate rose to 50%, then 60%. After another year, she was consistently selling 75% of the room after her speech. She had achieved outstanding results, but not to the level her instructor had promised. One morning, she sat down to breakfast with a few colleagues and her old instructor happened to be there. She couldn’t wait to speak with him and get direction about what could help her get that last, elusive 5%. What was the secret to finally breaking 80%? When she told her story to her instructor, his jaw dropped. “Eighty percent? You thought I said eighty percent? I said eighteen.”1111
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Why not choose to hear 80% when the rest of the world chooses to hear 18%?1125
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our easy start for the Profit Account will be 1% (that’s 0% historically plus 1%, starting today), and we will bump it up as we start getting into our quarterly rhythm.1171
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Why start with small percentages, when we likely could do more? The reason is, the primary goal here is to establish a new, automatic routine for you. I want the amounts to be so small you don’t even “feel” them. The goal is to set up these automatic allocations immediately, and then adjust the percentages each quarter until we are aligned with our TAPs.1175
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Right now, this moment, look at your bank balance in your Operating Expenses Account. Then subtract any outstanding checks and payments you have from that account. Divide up the remainder into your accounts based upon your TAPs.1189
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tally up the deposits, put them in the bank, and then immediately distribute the money to all the other accounts. Do this for every deposit going forward.1193
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Cutting expenses is generally a very quick process and is usually very easy.1203
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You can easily find your first 10% in cuts by doing the following: 1. Cancel whatever you don’t need to help your business run efficiently and keep your customers happy. 2. Negotiate every remaining expense, except payroll.1215
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That’s when Debra taught me the 10th and 25th cash flow rhythm— paying expenses twice a month, on the 10th and 25th. And that was the day the 10/25 Rhythm became integral to Profit First.1236
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I became less and less reactive about bills.1245
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Getting started: 1. Deposit all revenue into your Operating Expenses Account.
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Getting started: 2. Every 10th and 25th day of the month, transfer the total deposits from the prior two weeks to each of your “small plate” accounts based on your current allocation percentages. For example, let’s say you have $10,000 in total deposits for the past two weeks. Based on the following example percentages, here’s how you would allocate the $10,000: Operating Expenses 43% - $4,300 Tax 15% - $1,500 Owner’s Pay 30% - $3,000 Profit 12% - $1,200 Employee Pay ($750) - $0 Petty Cash ($50) - $0
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Getting started: 3. Transfer the specific dollar amounts from the Operating Expenses Account to respective accounts. In this example, Employee Pay for $750 and Petty Cash for $50. The accounts will now look like: Operating Expenses 43% - $3,500 Tax 15% - $1,500 Owner’s Pay 30% - $3,000 Profit 12% - $1,200 Employee Pay ($750) - $750 Petty Cash ($50) - $50
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Getting started: 4. Transfer the full account balances for both your Tax and Profit Accounts to the respective “no temptation” accounts at your second bank.
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Getting started: 5. You have $3,000 in the Owner’s Pay Account from which to pay yourself. Take only what you have allocated as your bi-weekly salary, and leave the rest to accumulate. For this example, we’ll say your bi-weekly salary is $2,750. This would leave $250 in the account.
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Getting started: 6. Pay your employees from the Employee Pay Account. For example, if you pay $675 this pay period, it would leave $75 in the account.
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Getting started: 7. With the remaining $3,500 in the Operating Expenses Account, pay your bills.
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Getting started: : Once you’ve done all that, the accounts would look like this: Operating Expenses 43% - $50 Tax 15% - $0 Owner’s Pay 30% - $250 Profit 12% - $0 Employee Pay ($750) - $75 Petty Cash ($50) - $50 Profit and Tax money will be accumulating at your “no temptation” second bank. As new deposits come in, you will deposit them in the Operating Expenses Account, and on every future 10th and 25th you will repeat these same seven steps.1256
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A big note here: There is a strong possibility that you will not have enough money in your accounts to do all this. If so, you’ve got a major wake-up call. When you don’t have enough money left over to pay your bills, it is your business screaming at the top of its lungs, warning you that you can’t afford the bills you are incurring. You are spending more money than your business can support.1284
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The new quarter has arrived. Yippee! You are about to take your very first ever quarterly distribution check. That’s right, baby. Your business is serving you, now. You are going to take a distribution check every quarter. Every ninety days, profit will be shared to you.1291
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On the first day of each new quarter (or the first business day after), you will take a profit distribution. Remember, the Profit Account serves a few purposes: 1. Cash reserves. 2. Metric to measure growth. 3. Profit. Tally the total amount of profit in the account (don’t add any quarterly distributions percentages from deposits you received this day, yet) and take 50% of the money as profit. The other half remains in the account, as a reserve.1300
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Every quarter, you will take 50% of what is in the account, and leave 50% alone. For example, let’s say you have saved $5000 in your Profit Account during the first quarter of implementing Profit First. On the first day of the new quarter, you will take $2500 as a distribution to the equity owners and leave the other 50% intact.1314
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The key is this: The profit distribution may never go back to the company. You can’t use a fancy term like “plowback” or “profit retention.” No term you use will cover up the fact that you are stealing from Paul to pay Peter. Your business must run on the money it generates for its operating expenses. The plowback of profits means you aren’t operating efficiently enough to run on the operating expenses. And if you give the profit back, you won’t experience the very important reward of your company serving you. You’ll just be letting the monster loose again. So always take your profit, every quarter, and use it for your own purposes. It’s celebration time!1320
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Every quarter, you will also pay your quarterly estimated tax.1336
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If you are adjusting and tweaking your percentages conservatively, I suggest that you account for three percentage points each quarter.1341
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If you owe taxes at year-end and don’t have the money in your tax account, this is the one time you can pull from your Profit Account for a reason other than profit distribution.1357
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Then adjust percentages in your Tax Account to ensure you will have enough for the next year.1360
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As your profits accumulate in your Profit Account, and you only take half as a profit distribution, the remainder will act as a rainy day fund.1365
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This is a simple analysis of what to do with your rainy day fund. First accumulate a three-month cash reserve for your business, so you have enough cash saved to operate unscathed for three months if all sales came to a screeching halt1368
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Then, when you see that the money in your Profit Account is in excess of a three-month reserve, you know this is a good opportunity to put money back into the business, to make some appropriate capital investments that will bring a lot more growth and a lot more profit, or to fund The Vault Account1370
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the fine print that says the bank can call back the entire loan at any time. Even if you’ve paid your monthly percentage on time every month, even if you’re not carrying a high balance, the bank can yank your line of credit without warning. And once the bank calls to notify you that they’re calling your line, the clock starts ticking. You have thirty days to pay back every single penny. Tick. Tick. Tick.1436
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This is the ultimate survival moment. If you focus all of your energy on paying down debt, that is all you will ever achieve. You’ll still be caught in the trap of top line thinking, which will likely result in more debt.1449
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He had had the equivalent of a financial heart attack. As soon as his big moment hit, he became a man on a mission—crush that debt immediately! By whatever means necessary, he would dig himself out of the crisis. His actions (or reactions) were the equivalent of a crash diet. He wasn’t giving any thought to how to make his business permanently healthy.1468
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Even when you and your business are in debt up to your eyeballs, you must establish a habit of putting your profit first. You must still (and always) pay yourself first.1473
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“If you have debt, be it one thousand, one million or somewhere in between, you need to kill that debt once and for all while still slowly and methodically building profit.”1476
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The Profit First system I’m teaching you will keep your focus on a super-healthy business,1477
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A profitable business happens when you save your pennies at every turn,1488
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Getting that healthy business all boils down to one really, really simple formula: You must consistently spend less money than you make.1491
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“The solution to debt is this simple: If you want to get out of debt, you must get more enjoyment out of saving your money than you do spending your money.”1510
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Wealth is a game of emotion. Business success is a game of emotion. Profit First is a game of emotion. It all comes down to the story we tell ourselves about what we’re doing. “Is what I’m doing making me happy, or not?”1513
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But pain just gets you to take enough action to get out of immediate pain. Then it stops working.1522
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The premise is simple—we avoid pain and move toward pleasure, putting a significant emphasis on the moment (remember the Recency Effect) and very little emphasis on the long term. Immediate pain gets the ball rolling, but pleasure keeps it moving.1524
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Give yourself more joy when you choose not to spend money than you do when you choose to spend it. Give yourself more joy when your bottom line grows (not just the top line). Give yourself tons of joy when your Profit Percentage grows.1535
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When Paul needs to purchase something, he plays the “Just One More Day” game. He challenges himself to go just one more day without the item. Every time he passes up an opportunity to buy whatever he needs, he gets pumped. He gets a high from going without for one more day.1566
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When you base decisions on your best revenue month, you will run out of cash—quickly.1576
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But it is typical behavior for entrepreneurs to look at their best month and tell themselves, “This is my new normal”— and then start spending and taking from the business accordingly.1585
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Projections are an opinion. Cash is a fact.1588
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If you have more money in the account then you take in salary, the difference in money stays and accumulates. This way, when (notice I didn’t say if) a slow month happens, money has accumulated in your Owner’s Pay Account and your salary stays consistent.1590
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So how do you predict the owner’s salary your company will likely support? Look at your slowest three months and average them. That is the lowest your revenue will likely ever go. Then determine the percentage of this income that will be allocated to Owner’s Pay (35% for example, times the average monthly revenue for the three worst months). Every quarter, we will do a salary raise based on how much money is in the Owner’s Pay Account and whether it is accumulating faster than we are withdrawing it.1594
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Fear is only amplified by a lack of knowledge.1609
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10. Next, evaluate your staff. Are there any people who aren’t “A-players”? Do you have any people who are actually bad for the company? Those people are costing you money in more ways than one.
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11. Ignoring the salaries and how you feel about the people, determine the following: a) which roles must stay in-house no matter what, b) which roles could be outsourced and c) which roles the company can continue without.
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12. Next, look at your people. Look at yourself. What roles could you take on? Now look at your best employees, the A-players. Can they be shifted around to cover the roles that must stay in-house? Are there any must-have roles that can only be handled by a specific person?1663
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Do not, I repeat do not, ask people to take a pay cut. I did this with dire consequences. Asking all your people to continue to work just as hard or harder than ever for less money is worse for the emotional welfare of your company than letting just one more person go.1698
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The point is this: Cutting costs is something that is very easy to put off for another day. It’s the mañana syndrome—I’ll get1723
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Everything is up for negotiation—your rent, your credit card rates and debt, your vendors’ bills, your software license, your Internet bill, your weight, your height, your age, everything. Your job now is to contact every vendor and get your costs reduced in the most significant way possible without hurting the relationship.1730
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Make the game one you win based upon efficiency, frugality and innovation, not on size, flair and looks.1754
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Momentum builds slowly but relentlessly. Small, repetitive, continuous actions, chained together, build momentous momentum1766
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pay off our debts with the highest interest rates first, but that doesn’t build emotional momentum. It is getting to tear up a statement—any statement, because it is fully paid off—that gives you a sense of momentum and gets you charged up to tackle the next one. Ramsey explains that you should sort all your debts from smallest to biggest, regardless of interest rates. Only when two debts are a similar amount should the one with the highest interest rate be paid first.1769
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And see how your enthusiasm and excitement about eradicating debt grows? You will get more and more pleasure from not spending than you once did from spending.1776
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You cannot add new debt as you pay off old. That is just shifting money around, paying down one debt while building another. You need to get your Debt Freeze on. And then destroy debt, once and for all.1779
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Cranking up the sales team in order to “make it rain” is not going to help your company if you don’t have efficiencies in place, because ultimately, whatever new client revenue you generate will have corresponding costs. And these are likely to go unchecked.1792
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If you want to increase profitability (and you’d better friggin’ want to do that), you must first build efficiencies.1794
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Why should you care about Idaho and its underground lakes? Because 95% of your company’s profitability is contingent on what goes on beneath the surface (after the sales), not what happens in the sky (the sales themselves).1802
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Greg Crabtree. Greg is the author of Simple Numbers, Straight Talk, Big Profits.1807
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Profit is a slippery animal. When profit margins are big, usually in excess of 20%, people sniff out and almost immediately start to duplicate what you’re doing, and look for ways to do it better, faster, and above all, cheaper than your company.1837
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before you can focus on sales, you must first nail Efficiency 101—and then take a few advanced classes.1843
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So the method is simple—achieve greater efficiency first, then sell more, then improve efficiencies even more and then sell even more. Over time, speed up the back and forth between efficiency and selling until the two happen simultaneously.1847
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I want you to set a massive goal for yourself. Look at every aspect of your business and determine how to get two times the results with half the effort.1856
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Letting go of clients who suck us dry and eat up our profit margins is a way of making space for clients we can serve exceptionally well by doing what we do best and with fewer resources.1891
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the top quartile generated 89% of the total revenue, while the lowest quartile only accounted for a meager 1% of total revenue. Wait. It gets worse. The study found that each group of clients required pretty much the same amount of effort (cost and time). This means that it took the same amount of effort to serve a big-revenue client as it did a client who barely affected revenue at all. Then came the awkward “gulp” moment. Strategex’s profit analysis showed that the top quartile generated 150% of a company’s profit. The two middle quartiles were effectively break-even, and the bottom quartile, the one that generated 1% of the total revenue, resulted in a profit loss of 50%! In the end, the profits generated from the top clients are used, in part, to pay for the losses accrued in serving the bottom clients.1898
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All revenue is not the same.1908
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Selling more is the most difficult way to increase profits, because in the best- case scenarios, the percentages stay the same; and in the worst-case, more common scenarios, expenses generated to support sales increase faster, resulting in smaller percentages and a smaller profit margin.1966
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Sure, stumbling across success is cool, but making a process for finding profits under the surface is the real success.1976
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Sales without first putting efficiency measures and systems in place is a dangerous game that only leads to bigger expenses and fewer ideal clients.1982
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The worst enemy of Profit First is you. The system is simple, but you have to have the discipline to implement it consistently.2040
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Rick Warren, a Baptist pastor, created his congregation. When Warren realized that his weekly motivational sermons were not enough to keep people focused on the lesson during the week and better able to meet challenges, he implemented small Bible study groups. His sermons were reminders of the lessons of their faith (a system of its own) and the small groups helped his congregation to stay focused on the lessons and implement them in daily life. Soon, 95% of Warren’s church activity was happening during the week, in the small accountability groups.2067
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Incidentally, Thomas Edison was part of accountability/ mastermind group with Henry Ford, Harvey Firestone and John Burroughs. They called themselves “The Four Vagabonds,” and though the group began as a camping tour, it was really much more. Together they mastered entrepreneurial domination and the ever-elusive secret trick to making a perfectly toasted marshmallow.2071
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“Easy,” he said. “The best student is always the teacher.” Ahh, yes. This is why we teach—to learn, and to master.2124
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To make it easy for you to start your own Profit Pod, I’ve created a structure for you to follow (see below) and a Profit Pod Starter Kit, which includes instructions and core guidelines for how the meetings are run. You can download your own free copy at MikeMichalowicz. com/Resources.2129
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A key factor in maintaining a successful Pod is to schedule your meetings a full year out, and then schedule your life around them.2167
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To secure the success of Profit First in your business, to really lock it down and ensure that your business will be profitable beyond your comprehension, you must hold yourself accountable to the process by whatever means necessary. Lead a group or join a group. Either way, you will achieve levels of profitability you would never hold yourself accountable for alone.2269
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you are about to learn the Profit First equivalent of running your first marathon. You need to be in shape and all stretched out before you do it. So please do proceed with reading, but don’t implement this stuff until you have completed at least two full quarters with the core stuff you learned about Profit First.2293
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An Income Account will give you an accurate picture of how much money you collected during any period of time. And the Operating Expenses Account will transition to only paying the expenses for operations, so you will have an accurate picture of how much money is flowing out of your business at any given time.2315
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on the 10th and 25th of every month, allocate all remaining money in the Income Account to the other accounts:2319
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The Vault is an ultra low-risk, interest-bearing account that you can use for short-term emergencies.2321
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Every business should have a three-month reserve,2324
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Few people have the discipline to think clearly or act appropriately in times of panic, and that’s why we document a simple set of instructions for ourselves in advance.2331
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The idea behind The Vault and the entire Profit First system is that it puts your decisions well out in front of any money crisis.2332
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EMPLOYEE PAYROLL ACCOUNT Employee pay is relatively predictable—full-timers are on salary and part-timers, for the most part, work an average number of hours per week. This means you can look at the cumulative gross pay for your employees plus the payroll taxes you’ll incur and allocate funds from your Income Account (if you use advanced Profit First) or Operating Expenses Account (if you use basic Profit First) to the Employee Payroll Account every 10th and 25th. If you use a payroll service, set them up to pull the payroll from this account (not your Operating Expenses Account).2362
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DRIP ACCOUNT This account is for retainers, advance payments and pre-payments on work your company will complete over a long period of time and for which you have yet to expend resources. Say you get a big project (congratulations, by the way), and you receive $120,000 from the client up front for work you will complete every month over the period of a year. That means that each month, you will really be earning $10,000. So when you get that check, put the $120,000 into the Drip Account and then automatically transfer $10,000 to the Income Account every month (or better yet, $5,000 every 10th and 25th). You don’t touch any of the balance in the Drip Account. You only make allocations when you drip a portion of the funds—in this case, the $10,000 each month—into the Income Account. The Drip Account will help you manage the true cash flow of earned money, so that you can manage your expenses and costs. For example, the labor doing the work will be paid monthly.2370
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PETTY CASH ACCOUNT Set up a bank account and get a debit card for petty cash purchases, such as client lunches. Then, allocate a regular dollar amount from your Operating Expenses Account to petty cash. Me? I allocate $100 every two weeks for myself, and also for a few employees who need it. The funds cover gifts, lunches and other small purchases.2382
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SALES TAX ACCOUNT If your business collects sales tax, every single, stinkin’ penny of the sales tax you collect is immediately allocated to this account. For example, if you sell something for $100 and sales tax is 5%, you will deposit $105 into your Income Account. First, transfer that $5 into your Sales Tax Account; then do your Profit First allocations with the remaining $100. Sales tax isn’t even legally your money; you are just acting as a collection agent for the government, so never, ever treat that money as income. Just bang people over the head for the sales tax and turn it over to the king (the government).2386
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The famed “monthly nut” is a horrible distraction. It’s up there with reruns of Jersey Shore. The monthly nut is a remnant of the GAAP mentality that simply tells us the number we need every month to keep the doors open. And that is nonsense. The “monthly nut” is a focus on—you guessed it—expenses, not profit. The concept of the monthly nut makes you focus on expenses and do everything you can to earn your “nut” with enough sales. In other words, it has us put costs first and makes the goal to cover expenses, not to improve profitability. Can you say “Survival Trap?”2406
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You get what you focus on, so stop focusing on expenses. Focus on profit and the expenses will be taken care of by default. Screw the “monthly nut.” Instead, focus on your Required Income For Allocation (RIFA). This is the money you need to deposit by the 10th and again on the 25th to have a healthy business, to pay the salary you want from your business and to take the profits you deserve. Period.2411
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Take your monthly, required personal income and divide it by two, since you are getting paid twice a month. Then divide that number by the percentage being allocated in Owner’s Pay.2414
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Also, you may notice that no bank summary “grand total” is shown in the table. The accounts aren’t all automatically added up to show a total combined balance. Many banks do this for your convenience, but I suggest that you disable the option (if you can). The grand total of all your accounts shows you all the money on one big plate again— exactly the thing we want to avoid. Looking at a grand total messes with your mind, so don’t do it.2431
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EMPLOYEE FORMULA There is a really simple formula for determining if you can afford a new hire—or if your business is currently understaffed or overstaffed. For each full-time employee, your company should generate Real Revenue of $150,000 to $250,000 (ideally more, but this is the minimum). So, if you want a million-dollar company, you know that you can afford four to six employees (including yourself).2461
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According to Greg, your Real Revenue must be two-and-a-half times the total labor cost if you’re running a tech business.2478
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on the other hand, you are in a “cheap labor” field, such as the fast food restaurant example I used above, your Real Revenue must be four times your total labor cost.2480
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HIDE ACCOUNTS Following the “out of sight, out of mind” theory, you are less likely to justify transferring or withdrawing funds from your accounts if you can’t see them. Some banks allow you to “hide” accounts so that you can’t see them on first view when logging in to online banking. Try hiding all of your accounts except for the Operating Expenses Account.2496
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For this tactic, set up all your outside income accounts so that any income is transferred to your main Income Account on a daily basis.2505
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The ultimate goal of the Profit First Lifestyle is financial freedom, which I define as doing what you choose to do whenever you choose to do it.2564
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I suggest you also read David Ramsey’s The Total Money Makeover. If there is a Bible for getting your personal finances lined up the right way, I believe his book is it.2573
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make the minimum payment on each debt. Then, regardless of interest rates (unless they are extreme), pay off your smallest debt first. Wipe that sucker out and then move on to the next one. Ramsey wisely says that paying off a debt, however small, creates a mental momentum that will motivate you to pay off the rest of your debt, faster. Remember, we are emotional beasts, not logical ones.2607
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we have a far greater desire to avoid losing something than we have to acquiring something. This behavioral response is called Loss Aversion,2639
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Combine it with the Endowment Effect—the theory that states that we place a much higher significance on something we possess than on an identical thing that we don’t possess—and you are dealing with a stubbornness2640
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That is the concept of Parkinson’s Law (nothing to do with Parkinson’s disease), in which C. Northcote Parkinson explained how our available resources (time, money) expand to fill the space made available for them.2690
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if you have ten dollars in your pocket, you will spend ten dollars. As our income increases, Parkinson’s Law takes over and we spend every extra penny we earn.2693
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in order for Profit First to have a permanent impact on your life, you need to build as big a gap as possible between what you earn and what you spend. The more cash you can collect the better, because at a certain point money starts earning you substantial money, all by itself. Money yields interest and returns from investments. And remember, once the money you have collected yields more new money every year than you spend in a year, you have achieved financial freedom.2701
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The idea of the Wedge Theory is to only gradually (and mindfully) upgrade your lifestyle as your income increases. Every time your income increases, you set aside half of the increase in savings so that you don’t expand your lifestyle to, as Parkinson’s Law suggests, “use all available resources.”2718
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not all expenses should be cut. We need to invest in assets, and I define assets as things that bring more efficiency to your business by allowing you to get more results at a lower cost per result.2843
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We use fancy terms to justify taking money out of our different allocation accounts to cover expenses. Two that are used most often are “plowback” and “re-invest,” which are really just other ways to say, “borrow.”2853
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When you don’t have enough money in your Operating Expenses Account to cover expenses, it is a big red flag that your expenses are too high and you need to find a way to fix them fast.2856
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As your profitability grows, your taxes will too. In fact, paying more taxes is an indicator that your business health is improving.2874
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don’t take money out of that Tax Account! Your business is growing by leaps and bounds, and higher taxes are definitely in your future.2881
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“The man who can drive himself further once the effort gets painful is the man who will win.” Right-o, Sir Roger.2896
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That’s all Profit First is—a simple system that works with us as we are. All you have to do is follow it.2927
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If logic worked, everyone would be rich. It’s simple—spend less than you make. But you’ve always known that, and now you know that logic alone doesn’t work. Leveraging your emotions and behavior is the most powerful profit-making tool. Profit first. Always.2943
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