Mike Michalowicz’s Profit First introduces a revolutionary approach to managing small business finances. By flipping the traditional accounting formula from Revenue – Expenses = Profit to Revenue – Profit = Expenses, Michalowicz ensures profit is prioritized. This transformative method empowers businesses to achieve financial health and sustainability. Here, we’ll explore the key principles from Profit First and how to implement them in your business.

Why the Profit First Method Works

The Profit First method challenges conventional accounting wisdom by focusing on profit as a primary driver of financial decisions. By allocating profit first, businesses are forced to operate within the remaining budget for expenses, ensuring financial discipline and sustainability. This method is particularly beneficial for small businesses struggling with cash flow and profitability.

Start by Taking Profit First

The cornerstone of Michalowicz’s philosophy is simple: Take your profit first.

How to Implement Profit Allocation

Every time your business receives a deposit, allocate a predetermined percentage to a separate profit account. This ensures that profit is never an afterthought.

Example: If your business earns $10,000 in revenue this month, and you’ve allocated 10% for profit, immediately move $1,000 into your profit account. This approach shifts your mindset from “How much can I spend?” to “How much can I keep?”

Use Small Plates to Control Spending

Michalowicz uses the analogy of smaller plates to explain why revenue should be divided into multiple accounts. These accounts include:

• Profit Account
• Owner’s Pay Account
• Tax Savings Account
• Operating Expenses Account

Benefits of Multiple Accounts

This system provides clarity and reduces the temptation to overspend. By assigning a specific purpose to every dollar, you ensure that funds for taxes or profit aren’t inadvertently used for operating expenses.

Embrace Parkinson’s Law to Boost Efficiency

Parkinson’s Law states that work expands to fill the time available. Similarly, expenses will expand to match the money available. By intentionally limiting the funds in your operating expenses account, you force your business to become more efficient.

Strategies to Reduce Expenses

• Negotiate better terms with vendors.
• Eliminate unnecessary expenses.
• Automate repetitive tasks to save time and money.

Example: A reduced operating budget might lead you to renegotiate software subscriptions or adopt cost-effective marketing strategies, driving innovation and efficiency.

Eliminate Debt with the Debt Freeze

Debt can cripple a business’s financial health. Michalowicz emphasizes aggressive debt reduction through a process called the Debt Freeze:

• Redirect cash flow toward principal repayments.
• Avoid taking on new debt.
• Cut unnecessary expenses to free up funds for debt repayment.

Benefits of Destroying Debt

By eliminating debt, you reduce financial stress and build a stronger, debt-free foundation, ensuring long-term sustainability.

Optimize Your Business for Maximum Profitability

Michalowicz encourages entrepreneurs to find hidden money within their businesses. Start by analyzing expenses, focusing on high-margin clients, and eliminating low-value activities.

The 80/20 Rule for Revenue

Often, 80% of revenue comes from 20% of clients. By prioritizing high-value clients and services, you can increase profitability without additional workload.

Example: If certain clients consistently generate high margins, consider tailoring your offerings to better serve this group while reducing low-margin services.

Work On Your Business, Not In It

A truly successful business operates independently of its owner. Michalowicz stresses the importance of creating systems and processes that empower your team to manage daily operations.

How to Build a Self-Sustaining Business

• Delegate responsibilities to trusted team members.
• Establish clear roles and processes for consistency.
• Focus on long-term growth and strategic planning.

Example: Empower your team to handle client inquiries and operational tasks, allowing you to concentrate on scaling your business.

Apply Profit First to Personal Finances

The Profit First principles aren’t limited to business. By using similar strategies for personal finances, you can achieve financial security and peace of mind.

Steps to Personal Profit First

1. Create separate accounts for savings, living expenses, and investments.
2. Allocate a percentage of your income to each account every month.
3. Prioritize savings to build a financial cushion.

Example: Allocate 20% of your income to savings, ensuring that financial goals like retirement or emergency funds are consistently met.

Key Benefits of the Profit First System

1. Financial Discipline: Ensures profit is prioritized.
2. Clarity: Multiple accounts simplify cash flow management.
3. Sustainability: Encourages efficient use of resources.
4. Debt Reduction: Frees businesses from financial burdens.
5. Profitability: Turns your business into a reliable income source.

Overcoming Challenges in Adopting Profit First

Transitioning to the Profit First system can be challenging, especially for businesses accustomed to traditional financial practices. To ease the process:

• Start small by allocating a modest profit percentage.
• Gradually increase allocations as you adjust to the system.
• Use financial tools or apps to automate allocations and track expenses.

Final Thoughts: Profit First Transforms Your Business

By implementing the Profit First system, you can turn your business from a cash-eating monster into a money-making machine. Michalowicz’s approach empowers entrepreneurs to take control of their finances, achieve profitability, and build businesses that support their lives—not the other way around.

FAQs about the book: Profit First by Mike Michalowicz

What is the Profit First method?

The Profit First method is a cash management system that helps businesses become consistently profitable. The traditional accounting formula, Sales − Expenses = Profit, often results in businesses never having any profit leftover. Instead of treating profit as an afterthought, Profit First suggests taking profit first.1 This is done by allocating a predetermined percentage of every deposit to a PROFIT account.

The system is based on four core principles:

● Use Small Plates: Divide incoming money into different accounts for profit, owner compensation, taxes, and operating expenses.

● Serve Sequentially: Allocate funds to accounts in a predetermined order, profit first, and never pay bills first.

● Remove Temptation: Keep the PROFIT and TAX accounts separate from the operating account.

● Enforce a Rhythm: Regularly allocate funds (e.g., twice a month) and distribute profits quarterly.

The Profit First method can be customized for any business by adjusting allocation percentages and adding accounts as needed. The system encourages businesses to think differently about their finances and prioritize profit as a habit.

How do you calculate Profit First allocations?

To calculate Profit First allocations, you need to determine your Current Allocation Percentages (CAPs) for each of your foundational accounts: PROFIT, OWNER’S COMP, TAX, and OPEX (Operating Expenses). The goal is to move your CAPs closer to your Target Allocation Percentages (TAPs) over time, but starting with smaller, manageable percentages is recommended.

Here’s a step-by-step guide on how to calculate your allocations:

1. Determine your Day Zero percentages: These are the percentages you were allocating to each category before implementing Profit First. For example, if you never took a profit distribution before, your Day Zero PROFIT percentage would be 0%.
2. Add 1% to your Day Zero Profit, Owner’s Comp, and Tax percentages: This will be your starting CAP for these accounts. For example, if your Day Zero PROFIT percentage was 0%, your starting CAP would be 1%.
3. Reduce your OPEX percentage by the total increase in the other three accounts: For example, if you increased your PROFIT, OWNER’S COMP, and TAX by 1% each, you would reduce your OPEX by 3%.
4. Every time you receive a deposit, calculate the allocation for each account based on your CAPs: For example, if you receive a $10,000 deposit and your PROFIT CAP is 1%, you would allocate $100 to your PROFIT account.

Example:

Let’s say your Day Zero percentages were:

● PROFIT: 0%

● OWNER’S COMP: 4%

● TAX: 0%

● OPEX: 96%

Your Day One CAPs would be:

● PROFIT: 1%

● OWNER’S COMP: 5%

● TAX: 1%

● OPEX: 93%

If you received a $10,000 deposit, you would allocate:

● PROFIT: $100 ($10,000 x 1%)

● OWNER’S COMP: $500 ($10,000 x 5%)

● TAX: $100 ($10,000 x 1%)

● OPEX: $9,300 ($10,000 x 93%)

This process should be repeated every time you receive a deposit. Remember, the key to successful Profit First implementation is to start slow and gradually increase your allocation percentages as you find ways to become more efficient and increase your profit margins. The system will make your cash flow clear and force you to prioritize profit, which will ultimately lead to a healthier and more profitable business.

What are typical Profit First percentages for small businesses?

Here’s a breakdown of typical Profit First percentages, or TAPs, for small businesses based on their Real Revenue:

Real Revenue	PROFIT	OWNER’S COMP	TAX	OPEX
Less than $250,000	5%	50%	15%	30%
$250,000 – $500,000	8%	40%	15%	37%
$500,000 – $1,000,000	10%	30%	15%	45%

These percentages are just a starting point, and businesses should adjust them based on their specific industry and financial situation. It’s important to note that businesses with lower revenue will generally have higher Owner’s Comp percentages because the owner is likely the only or key employee, with more of their time spent in the business rather than on the business. As the business grows, the Owner’s Comp percentage typically decreases as the owner transitions to working more on the business and building systems that allow others to do the work.

Remember to start with smaller, manageable percentages called Current Allocation Percentages (CAPs) based on your business’s current financial situation, as discussed in our previous conversation, and gradually increase your CAPs toward your TAPs as your business becomes more efficient and profitable

Note: Real Revenue is an alternative calculation to gross profit that simplifies calculations by subtracting subcontractor and/or material costs from Income

How often should I allocate funds between the Profit First accounts?

You should allocate funds between your Profit First accounts twice a month, on the 10th and the 25th (or the closest business day if it falls on a weekend or holiday). This regular rhythm is essential for establishing a consistent cash flow management habit and gaining clarity on your income and expenses.

Here’s a breakdown of why this frequency is recommended:
● Establishes a Rhythm: Similar to a heartbeat, the rhythmic flow of money creates a consistent pattern, allowing you to understand your business’s financial pulse. This predictable schedule replaces the erratic, reactive approach of traditional cash management.
● Reduces Reactivity: By reviewing and allocating funds regularly, you become less reactive to individual bills and deposits. This allows you to see the bigger picture of your cash flow and make more informed decisions.
● Reveals Patterns: The consistent rhythm allows you to observe patterns in your income and expenses. You’ll notice when bills are due, when income typically arrives, and how much money you have available to work with.
● Improves Control: By taking control of your cash flow on a regular basis, you gain a sense of control over your business finances. This reduces financial anxiety and allows you to focus on other aspects of your business.
Remember, allocating funds twice a month is the core of the Profit First system. This simple but powerful rhythm establishes a new financial habit and sets the foundation for a consistently profitable business.

Is the Profit First method suitable for all types of businesses?

The Profit First method is suitable for a wide range of businesses, but its suitability might depend on certain factors.

Business Stage: Slight modifications for new businesses might be necessary. Focusing on forming the basic habit and allocating 1% to profit, 50% to owner’s compensation, and 15% to taxes is suggested.
● Debt Levels: While Profit First can help businesses become debt-free, significantly high debt levels might require additional strategies alongside the core method.
● Industry-Specific Challenges: Some businesses might require additional accounts or adjustments based on their unique needs. For example, seasonal businesses with fluctuating income might benefit from a separate “DRIP” account.