I was first introduced to Profit First by Mike Michalowicz by a client of mine who was reading the book in hopes of finding a better way to keep tabs on her business’ finances. Sure, as her bookkeeper we were providing her with financial statements each month; but, as the book states, and I can attest,
I”m going to go out on a limb and guess that you only look at your financial statement[s] on occasion…And if you do, I doubt you review these docs on a daily basis or understand exactly what they say. But I bet you check your bank account every day, don’t you? It’s OK. 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 (Michalowicz, p.21-22)
Even as an accountant, I look at my bank account far more often than I look at my financial statements. The problem is that, many times, the balance in the checking account does not give an accurate picture of what is going on.
Have you ever gotten to the end of the year and had your accountant tell you to spend some money to knock down your profit (the amount you pay taxes on), only to find that there is no cash in the bank account to buy anything with? I hear it all the time, “I made $x-amount of profit this year but where is it? Certainly not in my bank account!” To make matters worse, if you can’t buy anything to knock down the profit, where are you going to come up with the money to pay the taxes on all that profit? It’s a no-win situation to find yourself in; but, an all too common one.
There are many reasons for this, none of which I will discuss here. However, Mr. Michalowicz has devised a brilliant system to ensure you no longer have this problem. The concept is based on the idea of having separate bank accounts for specific purposes so that you can view and monitor what you have for each simply by logging into online banking and viewing your accounts. All incoming money goes into one account and twice a month gets allocated to a minimum of four other bank accounts based on predetermined percentages: Profit, Taxes, Operating Expenses and Owner’s Compensation.
Profit is now set aside before any expenses have been paid and will be sitting in that account waiting for you to decide what to do with it at the end of the quarter or year. You also have a very clear picture of what you are allowed to pay yourself without putting cash or the business at risk. How many of us have skimped on compensating ourselves for the sake of keeping cash in the bank account? Taxes are set aside and ready for the tax bill and you know exactly how much you can spend on operating expenses because that is all that account will be used for (like bringing cash in an envelope to the grocery store – you can only spend what you brought).
Once I was introduced to the book and the Profit First system, I had it read and implemented in my business within one week. What did this do for my business? It tripled my Days Cash on Hand (the number of days my cash would last if not one more penny came into my business). It increased my ability to pay short-term obligations from $0.82 for every $1 of obligation to $26 for every $1 of obligation. It allowed me to pay my quarterly tax estimates on time because I didn’t have to worry about keeping that cash in my bank account as a “cushion.” When I got my tax bill, I had plenty of money to cover it and I was able to pay down debt and give myself some quarterly profit distributions.
I recommend this book for any small business owner who has struggled with the discrepancy between stated profits and cash in the bank or who would like peace of mind about the financial health of their business in real time, not with historical reports. Mike provides easy, actionable steps to get this up and running quickly and easily. The only area that may prove a bit challenging is if you don’t have an up-to-date and clean set of books to start with for calculating your initial percentages; but, it would be well worth your time and money to find an accountant or bookkeeper that can assist you with this initially.
Fortunately for us, unfortunately for you, this does not replace the obligation you have to keep a good set of financial records; however, that piece can be left to your bookkeeper or accountant while you enjoy the luxury of knowing exactly where you stand at any given point in time by doing what you likely have already been doing, logging into the bank and viewing the balances in your bank accounts.
Sources: Michalowicz, Mike. Profit First. Penguin Publishing Group, 2017, pp. 21-22.