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.
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.”
These percentages should be adjusted for your business and I recommend using the free tools on “Profit First” website to determine your percentages. However, the point is we need to understand where our money is going in order to visualize how to scale. The intention is to increase our profit and scale our business by managing our expenses/taxes. The best way to accomplish that is to put designated money in the right “bucket”. For example, I recently found that my operating expenses were consistently running at 20% month after month and my profit was creeping above 10%. Sounds great right? Well I was also incredibly busy and getting close to burnout. I was able to see that a small hit on profit would allow me to hire the help I needed to take some of my responsibility and free my time to focus on growing the business. How else would I have known this information? And how did I recognize this? I’ll explain.
On the 10th and 25th of every month, I move EVERY DOLLAR from the “income” account into the other 4 accounts at the percentages already specified (e.g. if $10,000 is in income, I move $5,000 to owner’s comp, etc.). See the image below. On the same day, I pay owner’s comp and ALL operating expenses. On this twice monthly schedule, you’ll never ever get behind on expenses again…ever.
Similarly, at the end of each Quarter of my fiscal year, I write myself a check for every dollar in the profit account and spend it on myself. Wait! What? Yep, you read that correctly. You are a business owner! You likely started a small business to experience some joy of profits. Have you ever felt that feeling? I have and it feels GREAT! My wife agrees. If you’re managing your expenses correctly using this method, you should be able to “invest in the business” correctly using what’s in your OPEX account, not from your profit. You earned that profit! Take it!
Taxes should be pretty self-explanatory but that account gets emptied on your Quarterly Tax Day. If you’re consistently putting 15% in that account, you should never have to worry about the tax man again.
What used to be a stress-filled nail-biter of an experience has turned into an exciting day that I actually (no-joke) anticipate. I get to watch my profit account grow and grow while keeping all my other bases covered. Not only that, I’ve been able to truly wrap my arms around my small business and poise for continued growth.
This blog has already gone too long so I’ll wrap it up but if this piques your interest, you’ll probably have a ton of questions. Feel free to ask but also, read the book. The Profit First method is much more detailed than what I described above and for our purposes I’m leaving out a lot of that detail. Feel free to explore on your own and determine how best to use this methodology to gain visibility and help your business grow!