If you’re ever familiar with the term “profit first”, you would know that it is an accounting method that takes profit into account first before calculating the expenses. This might seem like a straightforward concept, but many people don’t really understand the benefits that it offers.
Profit first is more than just focusing on profit, it brings a lot of benefits when it’s done right. Notice the word “done right”? Yes, if you want to ensure that you are doing it right, you can head on to a “Profit First Accredited Accounting Company” such as AccountedFor.
Here is the basic introduction to Profit First Method
What Is Profit First?
The profit-first concept was created by Mike Michalowicz. The main purpose of this accounting method is to earn profits, instead of revenue. You might be surprised that just a shift of mindset can immensely increase the cash flow management efficiency of the company.
Essentially, the profit first formula is as below
Sales – Profit = Expenses
What? Isn’t this just the same formula with a different variation? Yes, but the concept forces business owners to account for their profits first before managing their expenses. This creates a psychological effect that makes the business owner aware of the profit margins, which leads to them being more mindful of unnecessary expenses.
Profit First In Action
So how does the profit first theory work in real-life scenarios? The profit-first method requires businesses to think in percentages. It also requires business owners to open up different bank accounts for each section of accounting such as sales, expenditures and etc.
Businesses will also be immediately putting profits, taxes, and HR costs into different accounts if there is any incoming revenue, which is determined by the percentages that the business has agreed upon.
So how much does the business put into each account? You’ll need to decide on 2 types of percentage allocations :
Target Allocation Percentages (TAPS)
What are the split percentages of each section? For example, you allocated 50% of your profits as your business’ profits, 20% to HR expenses, 20% to other expenses, and 10% to taxes.
Current Allocation Percentages
This is the current representation of how your revenue is being spent.
As we can see, with the profit-first system implemented, you will be ensuring your profit in a savings account before spending more money on unnecessary expenses. This is especially beneficial for small business owners without big accountants working under them.
The Profit First Accounts
To implement profit first, we’ll need to have 5 bank accounts to distribute your funds for
- Income
- Owner’s pay
- Operating expenses
- Profits
- Taxes
Profit and Taxes should be stored in a savings account while the other accounts should be transaction accounts. Engaging with a business banking institution that supports profit first is also important as they are able to automate the system for you.
If you chose a business bank that does not support profit first, be ready to handle business banking matters all the time there will be a lot of funds that are held in the bank. Frequent visitations and high transaction fees will be charged, which is not optimal for your business finances.
Conclusion
Ultimately, the profit-first method puts yourself and your employees first before paying out to other people. It encourages the business owner to pay himself first. Although it has its disadvantages, the profit-first method has assisted multi-million dollar companies to achieve big profits roll, I don’t see why you should not!
Start earning your profits from your own business, increase your cash flow and start earning profit!