“Profit First” Accounting (Snoozefest Right?)

I don’t know about you but every time I hear the word accounting, I begin slowly drifting off to sleep. I know there are people in the world who were made for the discipline and I’m incredibly thankful for them. But, when it comes to doing it for my own business, the words I would use to describe it are Scary, Boring, and a “Necessary Evil.”

That is, until I realized I was doing it all wrong…

A year ago, I was like most businesses, using “Cash Accounting” to pay bills, pay myself, and determine whether or not I could grow or scale my little enterprise. To me this meant waiting until my business checking account had a little bit of money in it and then paying all my bills and writing myself a check for the remainder in that account.

Sound familiar?

I was constantly stressed about whether I would have “enough” for everything and I could never seem to get “ahead” to predict my costs and more importantly my revenues. When was the right time to start hiring team members? Where was my profit going? Did I even have any profit? All questions that small businesses like mine struggle with every day.

This all changed when a friend of mine (fellow business owner) told me I needed to read a book called “Profit First” by Mike Michalowicz. He had struggled with the same scale problems I had until he implemented the “Profit First” accounting method. Of course, I didn’t take his advice right away, because come on, I knew what I was doing. Accounting was easy and there was enough money to make ends meet. I put the book on the shelf and waited, too long I’m sure. However, when it did come time to look at the numbers and see if I had “room to grow”, I had no idea how to figure it out. Why? I had no idea what percentage of income my business needed to survive and what I needed to live on. Sure, I could look at the past Profit and Loss (P&L) statements but that was no predictor of future and gave me no insight into my current situation.

Was I going to be stuck here forever? Not knowing if could ever hire help or even take a vacation day.

It was then I remembered that a solution was sitting on my shelf ready to be implemented. I picked up the book and began to work on implementing the “Profit First” accounting method. I’m going to give a quick overview below but I highly recommend reading the book and using Mike’s free resources on the “Profit First” website to implement your own system.

At a high level, it’s similar to the “Envelope System” for personal finances taught by Dave Ramsey but much easier to implement in my opinion. All businesses of any size can bucket their revenues into 4 categories: 1. Profit, 2. Owner’s Compensation, 3. Operating Expenses, and 4. Income Taxes. I won’t describe all the line items that these labels encompass but for most owners I’m going to assume it’s self-explanatory.

The Envelopes in this case are business checking accounts. Most businesses have one or two business checking accounts but the Profit First system asks us to create 5, that’s right 5, business checking accounts. The 5th account is for all business “Income” and we will use that account to collect and distribute money to the rest on a specific schedule each month. Each checking account should be labeled like the accounts listed in image below.

Creating 5 accounts is the first step and I was surprised to find that my bank offered all these checking accounts free of charge for my small business. If yours doesn’t, go somewhere else.

The next step is to assign a percentage to each Account Label. Each business is different depending on your size and industry but for our purposes we’ll take a look at small businesses like mine. In the image below, you’ll see that I’ve assigned a percentage to each account except the “income account.”