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How much profit do you take from your business?
Perhaps you’re surviving from paycheck to paycheck and are more concerned with paying suppliers than taking profits.
Many solopreneurs and entrepreneurs also put paying themselves last, believing they should invest as much as possible into their business.
They apply a traditional formula of sales minus expenses equals profits.
This formula is broken according to Mike Michalowicz, the author of Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, as well as several other books.
The Problem with Putting Profits Last
Michalowicz is an advocate of Parkinson’s Law.
This law states work expands to fill all the hours available to it.
The same law applies to your health or business income.
Work will expand to fill the day and prevent you from exercise without self-discipline.
And expenses will expand to consume everything your business has in its accounts if you don’t act.
For example, an entrepreneur who puts paying themselves last might spend almost all of their revenue on marketing, advertising, working with freelancers and so on.
So their business turns into a cash-eating monster, consuming everything in sight, and that’s an unhealthy way of operating.
I would never say, “Oh, I’m going to start putting my health last.” That means it’s insignificant. If we really care about our health, we’ll say we put our health first.”
The same mindset applies to business, he continued. “[For] every transaction we have in our business, we immediately take a predetermined percentage of money—profit—allocated and hide it away.”
A New Formula for Business Owners
Michalowicz proposes a new formula: Sales minus profit equals expenses.
Putting expenses instead of profits last forces the business owner to exercise discipline about what they spend money on each month.
According to Michalowicz, more than 100,000 businesses have applied this formula. He started by explaining how he uses this formula as an author,
In the past, that royalty check would come in, and I’d say, “‘Okay, I have X number of dollars to support my business.” And I would spend it all away in marketing, in hiring a support team to help me writing my book.
Now … I take my compensation first. I made sure my taxes are reserved. I do those elements first. Then I see what’s truly left to run my business.”
How to Put Profit First
Start by setting up a bank account for your business income.
Next, set up four more bank accounts for profits, owner compensation, tax and operating expenses.
Ideally, set up the profits and tax accounts with a different bank, so you can’t immediately access them.
At least twice a month, and on a set day, allocate a percentage of what’s in the income account toward the other accounts.
Only then should owners concern themselves with expenses.
If the expenses account lacks enough money, this is a red flag that the owner should either cut costs or increase sales.
Michalowicz told me, “With less money I say, ‘How do I get the same results I’ve always had, if not better, with less money?’ And I start thinking outside the box.”
When I first applied the profit first formula, it took time to master using so many bank accounts and to determine my ideal allocation for each account.
According to Michalowicz, business owners will need to tweak their allocations for each category for several months until they find out what they and their business need to survive. (He provides guidelines in Profit First.)
After a few months of applying this formula, I found I didn’t miss the extra money for expenses.
Much like with creative work, this constraint forced me to explore new ideas for generating additional income.
I’m not alone.
Michalowicz said, “Consistently, businesses that take their profit first find ways to run more efficiently, more effectively … and grow profits like never before.”
April 11, 2019 at 08:23AM
Forbes – Entrepreneurs