If you’ve been an entrepreneur for a while you’ve likely heard of Profit First, by Michael Michaelowicz. It’s a great book worth reading if you want to have a sustainable business that builds generational wealth (which is what we are all about here!)
(This post contains affiliate links that, while they do not add any cost to you, do provide me with a small reimbursement. I do not recommend any products that I don’t love and am actively seeing value come from in my own life or the lives of my clients).
The premise of Profit First
The basic concept of the Profit First methodology is this – separate your money into different accounts so that you don’t have to keep track of it. He recommends the following accounts: income, profit, owner’s compensation, tax, and operating expenses.
Then he recommends having two additional savings accounts at a different bank: profit hold and tax hold.
That’s seven accounts at two different banks – are you exhausted yet? I mean, I get it. NO ONE, including me, wants to spend a ton of time tracking their finances. It’s boring as hell. But seven bank accounts are a nightmare. That’s not ease. I demand ease in my finances at all times and you should too.
Profit First the Leo & Vern method: Step One – Using the right account
If you don’t already have a business checking account, you need one. There is one checking account that I recommend above all others, especially when it comes to using Profit First. It’s from Novo.
- No fees
- Track income and spending in the app itself
- If you aren’t using a bookkeeper yet you can actually categorize your transactions in the app and it will run reports for you at the end of the year
- Physical and virtual debit cards
- Connects with Stripe, Square, Shopify, Paypal
- You can actually invoice from within the bank account
- Make payments with Wise, Venmo, Cash App, and Paypal too
- Connects seamlessly with your accounting software – QBO, Xero, Wave, Freshbooks
- Connects with payroll services – Gusto, ADP, Paychex
- Connects with budgeting apps like Mint, and You Need A Budget (more on this later)
- Has a great perks program with things like waived Stripe fees, instant Stripe payout, and discounts on Google ads, QBO, Gusto, and more
In addition to all this, they have a wicked awesome feature called “reserves” that make setting up your Profit First a cinch.
So, step one, get yourself a Novo account.
Profit First the Leo & Vern Method: Step Two – Connecting everything
Now that you’ve got your bank account set up it’s time to make sure that all your income will come into this new account. So go into your payment processors and update your stuff.
Now go in and update all your bills so that they will be getting paid out of this account. You want to have everything funneling in and out of this one account because good grief that makes it easier!!
Next, make sure you take the time to set up the ability to transfer money to yourself – because you deserve to get paid baby!! I do this by setting myself up as a payee in Novo so I can transfer my money regularly.
Got all that done? Whew! I’m proud of you! Let’s keep going!!
Profit First the Leo & Vern Method: Step Three – Creating Reserves
Now you get to start doing some Profit First actions! Go into your Novo account and create three reserve accounts: profit, owner’s compensation, and tax.
Why three? Where did income and operating expenses go? We’ll get there – hold your horses.
We also ditch the two other accounts at the other bank. Why? Because they just make things complicated. And complicated is not our jam around here. We want simple.
The concept of the reserves with Novo is to take the money out of sight without removing it from your bank account so that if you need it’s there! No more insane transfers at the last minute and having to spend out of the wrong account just to get the bills paid.
Profit First the Leo & Vern Method: Step Four – Determining your percentages
So in the Profit First system, there is something referred to as “TAPS” (Target Allocation Percentages). We’re going to call them percentages because we’re real humans.
The basic goal is to figure out what percent of your overall revenue should go into each category:
- Owner’s Compensation
- Operating Expenses
Fortunately, Profit First also gives us some pretty clear recommendations to start with. Since we have to total 100% (obviously) let’s start with the easiest ones.
Profit – 5%
This is a solid recommendation, don’t mess with it. Just do it.
Taxes – 15%
I’m going to say that I actually feel less awesome about this recommendation considering it’s extremely general and doesn’t remotely take into consideration your personal circumstances, whether you have people on the payroll, etc.
Takeaway? Talk to your accountant – explain your ENTIRE tax situation, and expected income, and get a recommendation of what this percentage should actually be.
Owner’s Compensation – 50%
I won’t lie, this is the one that people tend to ignore first. They spend as much as they make trying to “grow” their business, get burnt out as fuck, and then wonder why they don’t feel fulfilled in their business. Do NOT let this be you. 50% is a solid start but I personally work to help the businesses I advise run lean and pay themselves more.
Operating Expenses – 30%
I like this recommendation and when you look at what you’ve been spending you’ll either be super pleased with yourself or shit your pants. There’s not a lot of in-between on this one.
So how do you figure out what your percentages should be?
If we assume you’re sticking with the Profit 5% and you got some figures from your accountant and they say to sock away 15% (just for argument’s sake) that leaves you with 80% of your overall revenue to figure out.
First, figure out how much money you need to be bringing home for your personal life. Why start there? Because you DESERVE to be paid well enough to live your dream life. So if you don’t start here you will undercut yourself.
Next, see what percent that is from your overall revenue. So if you make $15,000 per month and you need to take home $8000/month then $8100/$15000 = 54%
So if we that means in this scenario your breakdown would be:
- Profit – 5% = $750
- Taxes – 15% = $2250
- Owner’s Comp – 54% = $8100
- Operating Expenses – 26% = $3900
Now if you look at what is left over for your operating expenses and you spend more than that, you can make some choices: find ways to trim costs or reduce your take-home pay.
I ALWAYS start with reducing business costs because running a business with minimal costs will help ensure that your business STAYS in business in the long term. Overspending on operating costs is the thing that will put your business under faster than Amber Heard on the witness stand.
Profit First the Leo & Vern method: Step Five – using the reserves
Now that you know your percentages it’s easy to implement Profit First using one bank account. You use your reserves.
Once your income comes in for the month (even if it comes in spurts) you know exactly how much you need to add to each reserve each month. Like that example above, when the income comes into the checking account you will go into Novo and select the reserve you want to add to.
If you wanted to put the $750 in profit you would click on profit, add and type $750. Then you will see the magic! The money is put into the reserve and REMOVED from the overall bank balance that shows as “available”.
The main reason that Profit First recommends different accounts is the idea that if you see it you will spend it. Reserves help with that because it takes it out of your overall balance so it LOOKS like it’s not there.
The downfall with Profit First and all its recommended bank accounts is that you are constantly transferring money back and forth and that’s annoying, plus if you get in a pickle the transfer may not make it to the account you need in time and then you end up spending out of the wrong account.
Using the Novo reserves the money is actually still IN the account it’s just tucked away from sight in your tidy little category. So each month you add enough to reach your goal for the month and then you’re done!
Profit First the Leo & Vern method: Conclusion
Using Profit First is widely held as the gold standard for financial management for small businesses and I wholeheartedly support it. In fact, determining percentages, monitoring progress, and implementing Profit First are one of my favorite parts of the CFO Services I offer my clients.