11 MIN READ
When it comes to allocating your Profit First accounts, you might assume that the order doesn’t make a significant impact. After all, each account is receiving a percentage of your overall revenue, so it shouldn’t matter which one receives it first, right?
Well, it turns out that the order you allocate your funds actually does matter. The Profit First methodology is designed to help you prioritize profit over expenses, and by placing the most important accounts first, you are reinforcing that priority. Plus, the order can also impact your cash flow and help ensure that you have enough funds in the right places when you need them most. So, while it may seem insignificant, the order in which you allocate your Profit First accounts can have a big impact on your financial success.
In the Profit First method, there are five foundational accounts:
- Owner’s Compensation
- Operating Expense
Allocating Profit First Accounts
We deliberately set up our accounts in this specific order to utilize our natural behaviors and take advantage of Parkinson’s law. Before we begin any allocations, we need money to allocate, which we call our income account.
So, let’s set that account aside since we can’t do anything without it. First, we have our Profit Account. I mean, it’s in the name “Profit First.” Since we tend to prioritize things that come first, we tend to put the things of most significant importance at the top of our to-do list.
After all, we are trying to make sure we profit, and it only makes sense to put the Profit Account first. Next, we need to ensure we get paid. After all, we can’t afford to work for free.
Once we get paid, we must ensure the government gets its share. We all know there’s no hiding from that one, so we might as well plan for it. Finally, what’s left over is for our operating expenses, the area we have the most control over.
So, let’s see how this all works.
How it Works?
During the month, money flows into your income account, and you just let it accumulate until your allocation day. When you make your allocations, you start allocating your percentage to your Profit Account. Now, maybe for the first time, you are seeing a Profit in your business. However, this time is different because this Profit relates to actual cash. That’s how You start to build the Profit Habit.
From a behavioral standpoint, this causes your brain to release dopamine. This dopamine makes you feel fantastic! Yay, your business is making a Profit, and you can see it! It is a massive boost to your confidence and motivation.
First, you allocate money to the Owner’s Compensation, another reward for your hard work. Again, you are paying yourself for the time and energy invested in your business. Yet again, your brain releases dopamine! You are starting to feel great about your business and how it supports you and your lifestyle.
Second, you allocate funds to Tax. Unfortunately, this isn’t a reward for you as a business owner; instead, it is more of a protection mechanism. This money means that when Tax Day comes around next year, you aren’t be scrambling to find the cash to pay your tax bill. It will already be there waiting for you. You are protecting the future of your business.
Lastly, you are allocating money to pay for your operating expenses. Finally, your operating expenses are the ones that need to live with what is leftover and not you!
Reward, Protect, Serve
Remember, what you are doing with this methodology is protecting yourself and your business.
Think about it, by ensuring your business is making a profit, you are making sure it has longevity and sticks around to serve your mission to your community. While your Owner’s compensation is making sure you get paid, you are ensuring that you can continue to deliver the mission you set out to deliver by starting your business.
By ensuring your Tax Account is flush, your business can afford to pay upcoming taxes so you can continue to deliver your services without worrying about having to figure out your tax bill.
Finally, your making sure your business only consumes what it needs by controlling how much money is in your operating expense account ensures you don’t have to worry about cash flow and can focus on what’s important—your mission.
Thus, reinforcing the reasoning behind the order of accounts and the order in which you make your allocations.
Since you are following this specific order, you are utilizing your natural behaviors and leveraging them to give you the motivation you need to continue. As humans, we like getting rewarded for our efforts. By using Profit First, your first two allocations are doing just that.
What happens when OpEx is short?
Let’s recap. Your business has made a profit, you have gotten paid, the government has its share, and all that’s left is to pay your business’s operating expenses.
That’s when you realize, uh-oh, I’m short. My business’s operating expenses are more significant than the money I have allocated to my Operating Expenses. So, what do you do?
Well, don’t panic. Do you remember when we talked about “Evaluating Your Operating Expenses”? We discussed the importance of regularly reviewing your operating expenses to determine your essential vs. nice-to-have expenses. Your essential expenses are things your business can run without, while your nice-to-have expenses are things that make your job easier or your office nicer.
Now you realize why we do this regularly. So, when your operating expense account is short, you don’t have to panic. Go through your prioritized list of expenses and cut some non-essential, low-priority expenses. A pre-prioritized list of expenses can help you quickly free up cash to cover essential costs without compromising your business. You may even be able to start building up a bit of cushion to your operating expense account to cover future unforeseen expenses.
We know cutting expenses is complex but think about it differently for a minute. If, for some reason, you’re short on cash, will the government give you a pass on taxes? Most likely not. Will your staff graciously take a pay cut or accept not getting paid? Again, probably not. How about your landlord? Will you still have to pay your rent? Probably.
Having a short operating expense account is a sign of your business. It’s screaming at you that you can’t afford your expenses and that you need to make a change.
So, what are my options?
As a business owner, financial stability is crucial. However, sometimes unexpected expenses or overestimated profits can leave you in a tight spot. When faced with this dilemma, it may be tempting to raid your Profit or Owner’s Compensation accounts. But, before making this move, consider the consequences. You’ll be sacrificing your business’s security and eliminating any rewards you may have earned for your hard work.
Instead, consider allocating profit First accounts and reducing expenses to maintain financial stability. It may take some effort, but it’s worth it in the long run. Don’t sell yourself and your business short. Give your business the financial security it deserves.
As a business owner, allocating profit is important. But what happens when your expenses outweigh your profits? It may be time to reevaluate your expenses and change your operations to run more efficiently. It’s easy to overspend on things that may not be necessary for the success of your business.
But it’s important to remember that if you can’t afford your expenses, you shouldn’t be spending money on them. Consistently managing your expenses is key to keeping your business afloat and ensuring its longevity. By doing so, you’ll be able to live within your means and avoid raiding your pockets to cover overspending.
Don’t wait until it’s too late. Start reallocating your expenses and budgeting for what you need to succeed.
Profit First Rhythm
Consistency is the key to success, and the Profit First Rhythm helps you establish just that in your financial life. One of the ways the system does this is by allocating profit First accounts, but that’s just the beginning. The 10/25th rule is another aspect of the Rhythm that sets the pace for your financial journey.
By dedicating two days per month to review your finances, you are establishing expectations and consistency in your money management. Whether you choose the recommended 10th and 25th of the month or two days that better suit your schedule, the important thing is that you are doing it consistently.
The benefit is that you don’t have to worry about your finances on other days because you know that you have dedicated time to address them. Establishing a Profit First Rhythm can be the key to taking control of your finances and ultimately achieving financial stability and success.
Taking control of your finances can be overwhelming, but with the right tools and habits, it can be empowering. One great habit to adopt is reviewing your finances twice per month instead of waiting until the end of the month, quarter, or year. By doing so, you’ll be able to track changes as they occur in your account and make informed decisions for your budget.
Allocating your finances to your Profit First accounts will give you a clear snapshot of where your money is going and allow you to amplify positive results or adjust your course if things aren’t going as planned. With a proactive approach to your finances, you can take charge of your financial destiny, make informed decisions and achieve your goals.
Profit First Mindset
The Profit First Method is just as much about shifting your mindset about money as it is about moving money between accounts. Putting your accounts in an order that works with your natural behavior and desires helps you achieve your goals.
In addition, you are getting into a pattern or a systematic approach to dividing your money. Regularly paying your bills and reassessing your expenses is a surefire way of ensuring that your business is running at top financial efficiency and allowing you to catch any potential threats early.
Early detection of any financial threats allows you to make timely course corrections and avoid a potential catastrophic shortfall. This simple approach will enable you to assess your financial standing quickly without reading overly complex accounting reports!
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