In these economically precarious times, businesses often struggle to maintain healthy cash flow, which can become a barrier to business growth and result in financial instability. Businesses have followed the same method when managing their cash flow: sales minus expenses equals profit. Although this formula is effective in some cases, there are other ways to manage finances.
The Profit First method is a great modern alternative to this traditional business account method. If you’re a business owner looking for ways to boost cash flow and reduce the risk of falling into debt, it’s important to get familiar with the Profit First method and how it can help your business. Learn more about this technique below to accelerate your company’s profitability.
What is the Profit First Method?
In layman’s terms, Profit First is an innovative method that prioritizes profit. This method involves setting aside a profit percentage before determining how many expenses a business can afford.
The Profit First method was introduced by author Mike Michalowicz, who identified the challenges businesses face when building a profitable business using traditional cash flow management methods. In his book, Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, Michalowicz came up with the principles of Profit First that involve categorizing your revenue into different accounts, most importantly, the profit account.
How Does the Profit First Method Work?
The Profit First Method involves ditching the traditional sales accounting formula and embracing the ground-breaking method to meet your company’s profitability goals sooner.
- Traditional accounting formula: sales – expenses = profit
- Profit First formula: sales – profit = expenses
One of the advantages of using this formula is its simplicity. Follow the steps below to implement this method into your business finances.
1. Determine Your Profit Margin
Look into your financial plan and determine what percentage of your revenue you want to allocate to profit. The number can vary based on your business size, type, goals, and financial needs. A standard recommendation is at least five percent of your business goals and needs, if applicable.
2. Create Multiple Profit First Accounts
Set up separate bank accounts for your business, including a chequing, profit, expenses, business taxes and owner’s pay, and an emergency savings account.
3. Allocate Funds to Each Account
Once you’ve set aside profit, you can create a budget for expenses and allocate a percentage of your funds to each account. For example, you can allocate 10 percent to the profit account, 30 percent to the owner’s compensation, 30 percent to the taxes, and the rest to other accounts.
4. Pay Expenses from Allocated Accounts
The last step is to pay your expenses from allocated accounts to avoid touching the profits. This will ensure that you maintain your cash flow levels and continue to make a profit.
Benefits of the Profit First Method
The Profit First method can significantly influence your business and help you manage your finances. This method allows business owners to maintain healthy levels of profit. Consider the following benefits of implementing the Profit First formula.
Improved Cash Flow Management
Cash flow management is a common problem for small businesses. A study revealed that 82 percent of business failures result from poor cash management. The Profit First method pushes you to automatically put profit aside before you even see it in your checking account, preventing you from spending it. This can bring your company closer to your overall cash flow goals.
If your company is new, you may still struggle to improve cash flow management. In that case, an installment loan may help you better manage your finances. Consult a reputable lender like GoDay to explore your borrowing options. You can contact a representative or read GoDay Blog posts on the lender’s website for guidance. A key benefit of an installment loan is that you can easily get access to the funds you need without a lengthy application process.
Keeps Business Organized
Using different accounts to separate your revenue can keep your business organized and allow you to make informed spending decisions. You will know exactly how much money you allocated for each account, taking the guesswork out of the process.
Streamlines Future Business Planning
If your cash flow is inconsistent, you may face challenges saving for expenses like utilities and taxes. Setting aside a percentage from each sale with the Profit First method allows you to maintain this habit and streamline future business planning.