Business Profitability: Applying the Profit First Method

Obviously, the goal of any business owner in 2023 is to make more profit. It’s one thing to have that overall goal. It’s another to actually achieve it. Nobody ever said running a business was easy, let alone reaching your full profit potential year after year.

Many entrepreneurs are adopting the Profit First method, which was developed by Mike Michalowicz. In his book Profit First, he shares his simple strategy for improved profitability—a method that can “transform any business from a cash-eating monster to a money-making machine.”

What is The Profit First Method?

The Profit First method is all about designating a certain amount of income as profit. It will take an adjustment of your mindset and will shake up your accounting model, but the approach is proving successful for many business owners.

Traditionally, profit is viewed as what is leftover after you subtract your operating expenses from your revenue:

Revenue – Expenses = Profit

Rethinking Your Profit Model

The business owner’s income is then traditionally taken from that profit, which can be a tough way to live if there are slim margins. With Profit First, you are setting aside a certain amount of revenue as your own pay. You are paying yourself first rather than last. This can create a much more stable business plan. Michalowicz calls these “profit contributions.” You are essentially factoring in your own income as an upfront operating expense. You take a certain percentage of each sale and/or set a consistent salary for yourself as a fixed expense.

This makes it more important to hit your revenue goals in order to cover all your operating expenses (including your pay). Less money is coming into the business, but you are potentially increasing your profit margins. Any remaining profit at the end would be divided into four profit pools:

1. Profit
2. Owner Profit
3. Growth
4. Cash Flow

Cash Flow Control

It is very important to have excellent control of your cash flow to ensure everything is being allocated properly. The Profit First method recommends distributing funds into five separate accounts. All revenue coming in should be split up based on your set percentages. Here are the business accounts to establish:

1. Income—The primary revenue that the business earns (before allocation).
2. Profit—An allocated percentage of revenue to cover unexpected expenses, or count toward additional profitability once all expenses are covered.
3. Tax—A fixed amount going toward business taxes.
4. Operating Expenses—Cash to cover all operating expenses—rent, supplies, salaries, travel, marketing, utilities, etc.
5. Owner Compensation—Your fixed salary or set percentage as the business owner.

Having these separate accounts helps you manage your money more effectively and make sure that a consistent amount of each sale is put into each account. You will cover your operating expenses, taxes and business owner compensation as necessary costs while still leaving room for additional profitability in the profit account.

Next week, we will dive deeper into how to allocate these funds and how to manage your remaining profit pools within the profit account.

For more personalized business planning and financial guidance for entrepreneurs, contact Illumination Wealth. Talk with one of our experienced advisors and get on the path to financial independence.