What is Profit First and how can it set your business up for success?
In this episode of the Bean Ninjas Podcast, Meryl interviews Michael Wark, Virtual CFO at Bean Ninjas. Profit First is a program based on the book written by Mike Michalowicz that gives you a simple cash flow blueprint on your finances to give you clarity, control, and ensure profits for your business.
We dive deep into Profit First, what it’s all about, how to set it up, common challenges in implementing it and addressing those problems. We also explore typical questions that business owners have on the Profit First methodology and framework.
In this episode, we discuss:
[03:48] Michael tells us about Profit First.
[05:15] Main problems that Profit First solves.
[07:58] The reason behind using the Profit First Methodology in the Bean Ninjas Money Mindset program.
[09:10] The Profit First Framework.
[10:54] Similarities between Profit First and the Barefoot Investor.
[12:56] The Parkinson’s Law.
[14:02] Michael explains how moving money works in Profit First.
[17:17] Common challenges people arrive at when using Profit First.
[21:21] Recommendations on the kinds of banks to use for Profit First.
[23:05] Variations on the allocations from the income account to various bank accounts.
[25:03] Working with Profit First even under debt.
[26:30] How accountants and Profit First Consultants can help small businesses.
Profit First – Benefits & Challenges for Small Businesses with Michael Wark
Announcer Welcome to the Bean Ninjas Podcast, where you get an all-access pass to see what happens behind the closed doors of a fast-growing global bookkeeping and financial reporting business.
Hey everyone. Welcome back to another episode of the Bean Ninjas Podcast. Today we’re going to be talking about Profit First. And Profit First is, I actually came across it about three years ago, maybe even more, when it was back in the early days of Bean Ninjas when I was still getting into Xero files and helping out with a bit of bookkeeping from time to time.
And I noticed that this particular client had a number of different bank accounts and they were moving money in between accounts. Cool things like the account had names like profit and operating expenses.
And talking to that business owner, she raved about Profit First and how it had changed her business and her ability to pay the self-wages and profit. And so at that time, that really got me interested. And so I went away and bought the book, Profit First, and learned a bit more about it.
And then, over the next three years, I started to notice other Bean Ninjas clients are also interested and to see more of the multiple bank account setup. And we also then started to get requests from clients around whether we could help in getting; helping them to implement Profit First in their business.
And we actually have enough of those requests to make it worthwhile; to explore setting up a related business, which we’re calling Bean Ninjas Money Mindset where our first product offering is Profit First Consulting.
And Michael Wark who’s been on the podcast a couple of times; he’s an accountant who’s been in various roles within Bean Ninjas. He, Michael, is a Profit First Consultant and running that business unit, and helping clients to implement Profit First in their business. And not just get it set up, but then also maintain the way that they’re using that framework.
So we have Michael on the podcast today, and he is exploring what Profit First is all about and diving into how you go about setting it up. But he’s also talking about some of the common challenges that he sees when trying to implement it, and how you address those.
And then in the last part of the podcast, we also have a chat about just commonly asked questions, like what sort of bank accounts to use, is there other any other adjustments that you can make to the framework, and he shares some insights around that as well.
So really interesting episode. We’ll dive into it. And as I said, if you’re interested in more of the backstory, then we’ll link to that episode in the show notes.
Hi, Michael. It’s great to have you back on the Bean Ninjas Podcast. It’s been a little while. You’ve actually been on a couple of different episodes talking about remote work and a conference that you went to. Was it Bali that we were chatting last time, we’re recording an episode?
I think we did, yeah. Yeah. I was over in Canggu in Bali. Yeah, we were talking about workday optimization. That was cool and remote work.
And where are you today?
I’m back in Sydney, Australia where I’m based. And yeah, working for my co-working space here. So back in Australia.
Yeah. Good. Great. Well, today, we’re going to be talking all things Profit First. So why don’t we start by explaining to the audience what Profit First is? I know that some people may have heard of it already, but there may also be some people in the audience who have never heard of it. So what is Profit First all about?
Well, it’s based on a best-selling book by Mike Michalowicz, with the same name, Profit First. And it’s a simple cash flow blueprint that helps bring clarity and control over people’s finances and their business finances. So it’s a system to help people build their business up in a sustainable way that sets them up for long-term success by allocating the correct funds to the correct sections of their business.
So the philosophy is anchored around a simple idea. First, you set aside funds for your profit, hence the name Profit First. And then, you also set aside funds to pay for your taxes and pay yourself as the owner; your owner’s pay or your wage. And then what’s left over is what the company has to spend on your operating expenses.
So it’s allocating the correct kind of amounts to the various sections of your business to make sure that it’s sustainable in the long-term, and that you’re not spending too much on one area, and that the business is balanced, and it’s a lean, mean money-making machine.
Love it. And I know when I came across the Profit First methodology three years ago; I think it was, it was really interesting seeing that accounting equation turn on its head. And traditionally, I’d seen a lot of business owners who; revenue was increasing, but they weren’t really controlling their operating expenses and there wasn’t a lot left when it came to profit.
So it was really interesting seeing how in this book, that concept gets turn on ahead. And instead of it being revenue less operating expenses, first of all, you’re putting inside profit and carving that out to make sure that you’re being rewarded for the time that you’re putting in to running your business and then having to make sure that you can cover expenses with the rest of the money that’s available.
So what do you see are the main problems that Profit First solves?
Look. There’s so many things that it helps address and there’s various levels to it. There’s the top level that you can do quite simply, but then there’s some more advanced strategies that really help with a whole bunch of stuff.
But the things that I think will be really helpful for our clients is number one, making sure the owner’s paying themselves properly and making a profit. We’ve seen some owners who have not, barely taking a wage, but they think that this is profitable. It’s getting that balance right.
It’s making sure people are putting enough; putting away enough for their tax obligations. We’ve got a lot of clients or we’ve seen a lot of clients with on tax office payment plans and stuff like that. So making sure you remember those obligations properly.
Debt is a huge one. It’s massive in Australia and around the world. So paying that down and trying to eliminate it from the business, and people’s reliance, especially on credit cards as well, which have their place in the business strategy, but they shouldn’t be propping up your cash flow.
And also just giving a bit of control and clarity about what expenses the business owners can commit to in the future. Like can you hire that new employee, can you afford that next big asset purchase? It’s giving you a system to help make those decisions in an educated way rather than hitting and hoping and guessing.
And it’s also, I mean, the most obvious and powerful part of it is removing your unnecessary expenses. So that’s trimming them down, making sure that everything that you’re spending is contributing to bring in revenue.
And obviously, not only getting your expenses under control, but we also start to look at in the more complex part of our coaching is improving your sales margins and getting paid a fair amount for your effort. So it does a lot, but it also is quite simple, which is why it’s so popular and why it’s quite powerful.
And we’re using the Profit First framework in the Bean Ninjas Money Mindset entity, which is something, if you want to learn more about the launch of that and the backstory, we’ve recorded that in a separate episode, and we’ll link to that in the show notes. And Michael, did you want to talk about why we wanted to use that methodology in that entity and what you’re seeing from that so far?
Yeah, absolutely. I mean, if we’re going to talk with authority about introducing Profit First, we need to walk the talk. So that’s we believe in it and we’ve seen the power of it in businesses that have transformed.
So it’s about walking the talk, and we’re running the system, and we want others to experience the power of taking back some control and working towards future goals that this system helps you bring.
So it’s about having credibility and authority, but it’s also, we believe it. And I think that’s really powerful. When you’re speaking about it to new clients who are talking about it, I can just talk about how it’s affected our business. It’s coming from a place of honesty, and I think that makes the conversations a lot more genuine.
Yeah, absolutely. So we’ve talked a little bit about what the key concept behind Profit First is and some of the problems that it solves. But how does it actually work? What’s the Profit First framework?
Yeah. So it’s kind of, it’s based on a waterfall system where all your income will flow into your top income account, your top bucket. And then, on certain dates that you can choose, depending on your needs, but the classic framework is the 10th and 25th of the month. All the income is moved from this bucket down to your foundational accounts based on the current allocation percentages that you set up when you first implement it.
So that’s just making sure how much you are spending on your owner’s compensation, your tax, and your operating expenses, and that’s just, we just calculate that as the percentage of your total income. And then from there, on the 10th and 25th, the money is moved, the relevant percentages are moved down into the various buckets.
And then from there, they can be used and spent on your paying expenses and putting cash aside for your tax. So it’s allocating your funds into the correct buckets, and then you leave them there for those specific purposes.
It’s about breaking it up so you don’t have one huge main operating bank account that everything’s being paid out of and you have absolutely no visibility over what’s in there and what should be in there and what you need to pay.
So it’s giving to you some clarity when you first log into your banking app or online, and you go, “Great. I’ve got this much for my expenses,” or “I’ve set aside this much for tax,” and “Great. I’ve got enough to meet my wage as the owner.” And that’s the basic premise of it.
We’ve got quite a few Bean Ninjas clients who already have Profit First in place before we even started offering the Profit First consulting and coaching. And it’s interesting to see how they feel about having profit set aside in another bank account. It makes it a lot more tangible.
And also, what I’ve seen is with the OPEX account, they’re really clear about how much money there is to actually spend on expenses and not going, not spending more than what’s actually available.
So it’s been nice seeing the benefits of having that clarity through the money that is set aside in different bank accounts from a couple of the clients I’ve seen that have implemented Profit First within Bean Ninjas. And actually, the bucket system, it takes me back to the Barefoot Investor.
And there’s no finances in the bucket system. Actually, we have a podcast episode about that; it’s one of our earlier episodes, and again, we’ll link out to that. Do you see some similarities between; I realized the Barefoot Investor is talking about personal finances, but have you seen any similarities between that methodology and Profit First?
Absolutely. Yeah, yeah. And I think they’re both addressing that fundamental human behaviour that helps us divide and conquer, if you know what I mean. So they’re both going about trying to attack the same problem in a different way.
So yeah, they definitely are. I think the Profit First system, it’s designed for businesses and it has a little bit more complexity to it, but yeah, I think it’s still addressing the same fundamental behaviour.
And I guess with this Profit First focus, you’re taking your profit first, which is the big difference. And you’re allocating yourself, the business is profitable from the get-go, and then the rest flows down into what’s left.
So yeah, you’re right. People do get excited when they start actually seeing that profit build, and they can go on and spend it on something nice to reward themselves for all the hard work they’re putting in.
Related: Profitable Coaching Business: A Guide to Improving Financial Health through Bookkeeping
And when you’re talking about the human behaviour, are you talking about the tendency to spend money that we can see is available? Or was there a different mindset that you would flag in there?
No, absolutely. Yeah, yeah. So, I mean, Profit First is based on Parkinson’s Law where work expands to fill the time available. So if you’re given a whole week to complete a report, it’ll take a week. But if you’re just given one day to complete that report, then this law says it’ll probably be done in this reduced time frame with the same quality, or sometimes better.
So pressure creates diamonds. And so, these diamonds are what we’re trying to unlock in your business. Little nuggets of productivity, and productivity gains, and then reduced expenses.
So the whole; this system is designed to try and do more with less, and make you hustle, and try and find those efficiencies in your business that perhaps you’d be getting lazy and weren’t really looking for that. So it hones your attention to those kind of areas, which is really, really powerful.
So we dig into the specifics of how this works. So you’ve described, on the 10th and the 25th of the month where we’re going to move; so the revenue is coming to that income account, and then, on the 10th and the 25th, we’re going to move that out into the different bank accounts, and you described like tax, profit and operating expenses. How do you know how much to move into those different accounts?
Yeah. That’s where the secret source comes in and that’s where it’s really important to set it up properly. So to begin, you should run a Profit First assessment in your business to see your baseline, and to see how you historically use cash in your business. And this isn’t the same as your basic profit and loss or balance sheet, I should mention.
So you need to categorize your cash flows into those key Profit First allocation accounts. So you work out; are you making profit at the moment? If so, what’s that percentage? And when I say percentage, I mean a percentage of your total income. So work out that.
Work out how much you’re paying yourself, work out your tax obligations, and then work out what you’re currently paying in operating expenses. So this is all boiled down to be expressed as a percentage of your income, which gives you your current allocation percentages.
And I should not; the devil is in the detail a little bit with what to put in these different accounts. So that is a little bit more complex and probably best chatting through the individual business case as they come up. But that’s the rough idea of working out how much people should be using to divide it up.
That makes sense. So if the initial Profit First analysis had been done, and say, I was running the particular business, and you might have picked it up, okay, we’re going to put aside 10% of profit. So if we had $10,000 come into the bank, so for this particular allocation period, then I’d be moving 10% of what came into that main income account often to the profit account.
Correct. That’s correct. Yeah.
And if you’re doing 10% profit, that’s awesome, by the way. That’s not where a lot of people is at.
Yeah. I plucked that number because it was easy.
That’s bravo to that business, and I should note that you should start quite small, and quite slowly. I know we’re going to address challenges later on, but a lot of people jump in and try and start giving themselves 15% profit to begin. And if you’re doing that, then you’ve got a great performing business. But you need to start this habit slowly and just adjust above 1% to begin.
So that’s something really important because you don’t want to pretend that you’re a really profitable business from the beginning. It’s making sure you get your starting point right because that’s the number one problem is that people don’t have that starting point right, and then they’re trying to hit a goal that is based on fiction. And so, the whole system starts to break down and they lose motivation to do it.
Well, while we’re on this track, let’s talk about challenges and the example that you were just describing. I can imagine if you were being unrealistic and say that you’re going to take 15 or 30% of revenue as profit and you’re paying that out to yourself. And then all of a sudden, there wasn’t enough money in the operating expenses account, then it would cause the Profit First system to break down. So I think that’s great advice.
What are some of the other common challenges that you see around getting results from Profit First?
Look, it does require discipline, especially when you’re setting it up. It’s designed to work with our human behaviour. But it’s setting up the system and sticking to it to build that habit is obviously really important.
And that’s why we provide like a coaching service who try and provide that accountability to people, and you can’t do it half-hearted. You have to, ‘in for a penny, in for a pound.’ You need to; that’s not a financial hack; it’s supposed to be a new way of looking at your business on operating.
So as I mentioned, if people get their initial current allocation percentages wrong, it gives you the incorrect starting point. You start off from the wrong place, so how do you know where you’re going to be heading?
And then, especially with larger businesses or more complex businesses, there’s challenges that come up with how do you manage making your payroll payments or if you’ve got large inventory payments or assets, and use this system without running out of cash in your accounts. That’s another really common one.
Then there’s techniques to help with this, which is making sure you get the timing correct when you’re making your allocations and then paying your expenses; trying to get them in sync.
And then also, for big inventory payments for like e-commerce clients, you can break out a different; another bucket, and then track your inventory payments in this, and make sure you’re putting aside funds for those big inventory payments at each allocation.
So there is ways around it, but it’s about building the habit and actually living the new principles. You can’t start stealing from the other accounts because you run out of cash. That’s a red flag that you’ve set the incorrect percentages to begin, and then pay for [Crosstalk 00:19:28]
I’m sure that it’s very tempting to do that.
Yeah, yeah. Absolutely. And then you’ll lose faith in the system. You’re like, “Well, the system is broken because I’ve run out of cash.” But you forget that the system is designed to cut down your expenses, to be your lean, really focused business.
And so, maybe that means not going to your third conference for the year, or maybe that means, you know, there’s a whole bunch of ways you can cut cash from a business. But yeah, it’s about trying to trim those expenses and focus on getting a really lean business to begin. And then from there, it will really help you grow in a profitable way.
Another one is when like people have a tough month, their income drops for that month, they’ve got less cash to meet their expenses because like, “Well, 30% of 10 bucks isn’t very much, and I can’t meet all my expenses with that.”
And that’s when they start relying on credit cards, and then that they start relying on other short-term finances, which is great in the short-term, but long-term, there’s ways to try and remove these crashes.
And one of the thing is building up your vault, which is another account in the more advanced techniques where you have three or six months’ worth of operating expenses; you’ve got cash there ready to go for emergencies. So it’s kind of building up a little bit of a cash war chest for those times.
And then other things like, what the hell do you do with sales tax or GST? Are you counting that when you’re looking at your total income? So you make sure you strip that out. So I mean, every business is different, and there’s a whole bunch of things, techniques you can do to address all of these problems.
But yeah, once it’s set up and rolling and turned into a habit, it’s a simple system that, as I said, the devil is the detail, and you just got to make sure you get it all right to begin.
Yup. Next, I wanted to move on to some commonly asked questions. So this is getting into some of the nitty-gritty if you’re implementing this. So the first question is related to banking, because obviously, you need to set up a whole bunch of new bank accounts to make this method or this system work effectively. So do you have any recommendations around which banks to use if you’re doing Profit First?
Yeah. I mean the banks’ offerings are changing all the time, so I don’t think I’ll list specific banks. But stateside, I know people have had a lot of great success with credit unions and community banks.
The one thing I would say with those type of banks is make sure that they plug-in to your accounting platform. Obviously, we use Xero. So you’ve just got to make sure you’ve got a nice, stable bank feed before you go out and create these 8 to 10 new accounts. You’ve got to make sure the flow and effects are there.
So yeah. Credit unions and community banks, and some of the new online banks are really switched on, and they let you open up a brand new account at the drop of a hat. So there’s that new breed of fintech banks that are coming online that are really switched on with this kind of systems and are playing into that.
But here in Australia, I have noticed that a lot of the bigger banks are now starting to get on board and cutting down their fees for these additional accounts. So it’s just a matter of speaking to who you’re with currently, seeing if they can actually do you a deal for this. And if they can’t, then that’s where you can look elsewhere.
And if people; we’ve got a couple of lists of banks that I’m more than happy to share. So just get in contact with us on our website, beanninjas.com, and I’ll flick you through. I’m more than happy to share that list with you, depending on where you are; stateside or Australia.
Great. So the next question is about when you do the allocation from the income account into the different bank accounts. In the book, it recommends doing it on the 10th and the 25th, and can it be any variation with that? Would you ever recommend doing it daily or weekly or anything different than the 10th and 25th?
Yeah. Absolutely. And this goes for the entire system, it’s very flexible depending on the business and it can breathe with what your business needs. There’s always a way you can fit it in.
I think Mike, the author, recommended that because that’s a nice fortnightly schedule. A lot of payrolls done fortnightly, a lot of accounts payables done fortnightly, so it kind of, it probably suits the majority of businesses that you do the allocations and then do your fortnightly AP run straight after when you have that cash.
So I understand that is kind of the book’s main suggestion. But we’ve got clients who do it weekly, and then we’ve got smaller clients who do it monthly because they can survive for a month without making those allocations. So it’s just about what the cash demands are for your particular business and making sure you fit them in to suit that.
So the next question is about if I wanted to get started with Profit First today, is there anything; can I do it retrospectively? Can I go back and change anything or is it something that I can only do from today and moving forward?
Yeah. Doing it retrospectively is probably not an option and you can do it from the day you start Profit First; you can start doing it. But I don’t think you need to do anything retroactively. There’s a pretty simple way you can transition from your old bank accounts into the new ones, but it’s a forward-facing thing and there’s no point really doing it looking backwards.
Yup. Next question is will Profit First work if I’ve got a whole lot of debt?
Yeah. Absolutely. Definitely. If you’ve got a lot of debt or the business is struggling a little bit, this system is really good for you because, as I said, it makes you really focus on what expenses are crucial to earning your revenue and trimming down the excess, and there’s various techniques you can use to help pay down this debt in a controlled way.
There’s the debt snowball and the debt avalanche, which, if you can get in contact, and I’ll send you a bit more info on that. But it’s basically a strategy to try and minimize that. So if a business does have a big chunk of debt, instead of taking, say, your 5% profit, we recommend, still, take 1% because it’s important to build that habit of taking profit first, but the remaining 4% all goes to paying down that debt.
And so, that’s where any excess cash in your profit account should be paying off debt. And also, any cash leftover in your operating expenses, once you’ve met all of them; if there’s anything sitting there where you’ve had a good month and you’ve been able to be pretty good and control them, then that should be paying off debt as well.
So there’s definitely frameworks to help you do this and you do it in a controlled manner in a schedule, and really focus on cutting that out because those kind of interest payments, they’re a killer. You know, you’re not getting any value for that. And yeah, so there is, definitely.
And if you like the idea, so you say you’re a small business owner and you like the idea of getting started with Profit First, but some of it feels a little bit challenging, like kind of work out the right percentages to allocating your business, are there things that an accountant or a Profit First Consultant can help with?
Definitely. Yeah, yeah. There’s a growing army of them and they definitely can. As I mentioned before, the system is quite simple on the face value, but once you start to dig in and look at specific situations, it can get a little bit more complex.
So they can help you get the set up correctly with the right percentages and set achievable and realistic goals to get you moving in the right direction and get you excited about that. They can tailor it to your specific needs.
So, you know, some of the situations I mentioned earlier; there’s different strategies to deal with all of those. Set the right goals for your specific situation and not kind of try and compare yourself to the market leaders and maybe just look at, “Okay. What’s the average doing? What’s the mid-market doing?” Let’s get there and then reassess the goals once you’re at that stage.
A big part of coaching is obviously keeping people accountable. So having that person; I mean, this system is designed for the business owner to be driving. It’s behavioural. It’s trying to adjust their mindset.
But if you’ve got a Profit First Consultant in the passenger seat with map, getting there is going to be a lot easier, and having that person to bounce ideas off and share the wins and the losses with I think really helps with motivation and actually achieving it.
And then we can, I mean, I’m available to help people celebrate without extra profit. I like champagne and I like surf trips. So if they need help without extra funds, we’re available for that, too.
So where should people go if they’re interested in finding out a little bit more about Profit First or working with you?
Yeah, absolutely. So if you just go to beanninjas.com and fill in the Contact Us Form, I’ll be able to get in touch and give you a little bit more info. We also have a blog post that explains a few more details about this that we can link in the show notes.
And I’m also on LinkedIn. My name is Michael Wark, w-a-r-k. And yeah, find me there and hit me up, and we can chat there as well.
Great. Thanks so much for coming on, Michael.
Cool. Thanks for having me, Meryl.
Do you want to improve cash flow or get started with Profit First in your business? Well, we’ve got a resource that might help you. It’s called our Profit First Kickstarter Kit and it includes two chapters; so the popular Profit First book by Mike Michalowicz, and it also has a template that will help you to make your Profit First allocations.
References and Links Mentioned:
- Profit First by Mike Michalowicz
- Your 90 Day Plan to Profitability using Profit First
- Blog: Bean Ninjas Launches Profit First Program and Coaching Services