How does Profit First work?

Small businesses must maintain healthy cash flow and avoid becoming buried in debt in these economically challenging times. Often, however, this is easier said than done. Particularly when it seems like money is disappearing from your account faster than you can make it.

Through your accounting approach, Profit First can help you improve your company's cash flow. 

By rethinking their approach to budgeting and cash flow management, this method was developed by Mike Michalowicz and detailed in his book, Profit First.

It may be difficult to unlearn what you know about managing your company's finances, but it can improve your profitability and control your company's liquidity.

An explanation of Profit First accounting

Putting profit at the forefront of accounting is the essence of Profit First. 

To calculate profits, business owners traditionally use the following formula:

Sales – Expenses = Profit

This equation is reframed by the Profit First formula - which puts profit first. From each sale, profits are automatically deducted and the remainder is used to cover expenses. Therefore, the formula is:

Sales – Profit = Expenses

Even though this shift is subtle, it encourages business owners to pay more attention to their profit margins and expenses, allowing them to identify wasteful expenditures more easily.

How does Profit First work?

Instead of paying themselves with what's left over after expenses have been accounted for, Profit First requires businesses to deduct profits from their payments before expenses. To cover profits, taxes, overhead costs, and your own compensation, you transfer predetermined percentages of your incoming funds into different accounts.

The amount deposited into each account is determined by Target Allocation Percentages (TAPS). 

Profit First method percentages

According to Profit First, business owners should think in terms of percentages. Start by calculating your Current Allocation Percentages (CAPS). As a benchmark against TAPS, this shows how your revenue is currently spent. 

Aspirational goals are part of TAPS. They focus on how your financials should be split in order to improve cash flow, ease profitability, and fund business expansion.

Advantages of the Profit First method

Profit First has numerous advantages:

• Relatively quick and easy to incorporate into your operations

• Encourages you to think in terms of profitability rather than revenue

• Yields immediate results in the profit section of your P&L statement

Encourages business owners to be proactive in setting the profit margins on products and services

Disadvantages of the Profit First method

Using Profit First has some potential caveats, as with any accounting method:

• Can be difficult for new startups (who think of profit in terms of monthly cash flow) to adopt

• Not all outsourced accountants are familiar with the method

• May take time for your team to adapt to Profit First thinking

Implementing the Profit First method

Profit First can be implemented in a variety of ways. Consider reading the book and encouraging your team to do so, and see how its principles can be incorporated into your accounting. The UK also has a number of Profit First-trained accountants including Suzy Kerton from Zyla Accountants.

Your operations can benefit from identifying money leaks and focusing on profitability in a variety of ways. Your business could increase its profit margin by using bank-to-bank transfers instead of credit or debit card payments.

We can help

To learn more about Profit First, contact Suzy Kerton at Zyla accountants today.