How to manage your cash and drive profitability without knowing your debits from your credits!

Why I am now using the Profit First System, and why I think you should too.

I have been on a mission. I have been trying to figure out how to help my small business clients better manage their cash, control expenses and maximize profitability without trying to learn accounting or creating some kind of complicated system that would take a lot of time and effort to implement. I knew how important this was to small businesses. Cash was one of their most precious resources, followed closely by the owners time. I knew this was an ongoing struggle and I needed to find a good solution.

Where can you turn for help? You could hire a CPA or maybe even a part-time CFO to help you work through this. There are a couple of problems with this idea.

1. Professional advice is expensive. The cost vs the benefit you receive might be tough to justify.  Maybe you are just too small to afford it.
2. Most CPAs focus on compliance activities like taxes and audits.  Some do this kind of analysis but it just might not be in their wheelhouse.
3. CFOs are good with highly complex situations.   Their solutions might be overkill for you.
4. All of these people speak a different language than you making it difficult to understand and follow their advice.

Maybe you have a bookkeeper do your books. But are they giving you advice on how to manage your cash? Very few are skilled in this area. They probably just take the information that you give them and translate it into financial statements using Quickbooks or some similar program. But then what? What exactly do you do with those statements? How do you use them to move your business forward?

Accounting is like a foreign language. Reading a financial statement is no problem if you know the language. If you don’t, it might as well be written in Greek…because it is to you.

So here is where most small businesses turn to the one tool that they know…their checking account balance. They look at the bank balance to determine what they can afford. The problem with this approach is that almost every small business operates in cycles. It can be feast or famine. The result is that in the feast stage spending is free and easy. It feels like the good times are here to stay. Suddenly you have committed to a lot of monthly expenses that you can only afford if the good times are here to stay…but they never do. The famine comes again. Now what? You hope that you can hang on long enough to get back to the feast…if not, you become another small business statistic.

There has to be a better way. I had been working with other small businesses to try and figure out that better way. To help them build a map that they could just follow that would lead them in the right direction. Something that they could use that would give them confidence that they were on the right path. Something that was simple to understand and could be made into a system that was easy to implement.

Then I found Mike Michalowicz and Profit First!

Thank goodness! I could stop trying to invent the wheel because Mike already had. Once I read his book, I was hooked. This was exactly what I was looking for; a super simple way to manage your cash, and drive profitability.

It all starts by flipping the switch. The usual formula that accountants use is :

Sales – Expenses = Profit

The result is that profit is whatever is leftover. So the business owner focuses on sales, then spends money on expenses and hopes that there is something leftover. Do you really want your profit to be the leftover??

The switched up formula is:

Sales – Profit = Expenses

Logically, from a math standpoint, these are the exact same equation. But from a behavior standpoint, it is completely different. Expenses become the leftover. You plan the profit from the start and only spend the leftover. The benefit of this approach is that it forces you to get innovative about your expenses. It also keeps your expenses in line with sales. And it keeps you from accidentally spending your profit.

The Profit First System

The profit first system works on four principles that were developed borrowing strategies that have worked in the diet industry. The four principles are:

Use smaller plates – If you normally fill your plate and eat it all, using smaller plates will automatically reduce the number of calories that you consume. You can use this same theory with your money. So how this works is that when your money comes in, you divide it up into smaller plate sizes. There is a plate for Profit, Owners Pay, Taxes and Operating Expenses. Normally you would put all of your money in the same account and then spend it all on operating expenses and struggle when you needed some to fill another need…like money for you.

Serve sequentially – If you eat your vegetables first, then you make sure that you get the nutrition and vitamins that you need. If you eat them last…well, maybe you are just too full. So how you apply this to your money is that you have separate accounts established for each of your “plates” and you allocate money in the following order:

1. Profit Account
2. Owners Pay Account
3. Tax Account
4. Operating Expense Account

And if there isn’t enough money in your expense account to pay your expenses? That is your business telling you that you can’t afford those expenses and it is time to get creative about how to reduce them.

Remove temptation – Just like you don’t keep the wrong foods at your finger tips you don’t want to have easy access to the money you are trying to preserve. Make that money hard to access. If you can just move it around with a click of a mouse, it will be easy to just “borrow” from one of the other accounts when things are tough.

Enforce a rhythm – In the diet industry, they encourage you not to wait to eat until you are starving. This just causes you to binge on the wrong thing. You want to have regular smaller meals so that you aren’t getting to that point. With your money, you want regular times set up to do payables and to move your money to the proper plates. This will give you a controlled recurring process rather than a seat-of-the-pants cash management.

So those are the principles. It is an easy system that pretty much anyone can understand. But what if you haven’t been making a profit and your expenses are out of whack? The key to getting started is to start from where you are and set goals to work toward. Start small and move toward a bigger goal incrementally.

What is a reasonable goal? What do financially healthy businesses do? This is where Mike has done a ton of research and looked at what percentage the healthiest businesses use for each of the categories of Profit, Owners Pay, Taxes and Operating Expenses. Of course you can make adaptations to suit your business specifically but this is a good place to start.

You don’t need to get the numbers perfect. Imperfect numbers are probably way better than what you have been using. There is always time for refining the process once you get started. You are going to start gradually anyway. The main thing is to start. Reserve that first money…see what that feels like. Then get creative about how you can do more.

Mike has a whole book on this process that provides a lot more background and detail. I highly encourage you to read it. If you have questions that I can help you with, feel free to email me at me@maryellenmiller.com or ask in the comments below. I really think this is an incredible system that can be a game changer for your business.

What do you think?  Comment below!

 

 

 

 

 

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