Week 6 – Why Sequencing Your Profit First Accounts matters?
12 MIN READ
Sabrina Pelech, Profit Catalyzer
12 MIN READ
The Profit first methodology has you putting money in your various Profit First accounts by allocating a pre-determined percentage of your overall revenue. So, at first glance, you might think that the order of these accounts is unimportant. Since all the account allocations add up to 100%, the order in which you make the allocations should not matter. Right?
However, that is not true. The order in which you allocate your funds dramatically impacts your business. Not only by dictating how you feel about your business but also your overall success.
In the Profit First method, there are five foundational accounts:
- Owner’s Compensation
- Operating Expense
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.
“The question isn’t how big the business is, it’s how healthy the business is.”
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?
Well, you have 3 options:
- You can raid your Profit account and end up with no reward for the risk you took running your own business.
- You could raid your Owner’s Compensation account and not pay yourself for all the hard work you put into your business daily.
- You can reduce your expenses and thus reduce the amount you owe.
While options 1 & 2 Are the easiest, you don’t have to cut expenses or make any changes to your business. You end up sacrificing your business’s security by removing any cash cushion it has.
You eliminate any reward you get for managing a successful business. Furthermore, you are not getting paid what you deserve for doing your job within your business.
So why would you do that?
Wouldn’t it make more sense to reevaluate your expenses and change your operations to run more efficiently? That way, your business starts to live within its own means, and you can stop raiding your pockets to cover overspending.
After all, if you don’t have the money to cover your expenses, you can’t afford your expenses.
At some point, your business will continue to drain cash while your profit and owner’s compensation accounts run dry. Then what? You have costs you still can’t afford but no accounts left to raid.
Consistently managing your expenses is critical to your business’s success and longevity.
Profit First Rhythm
Everyone likes Rhythm; it sets a pace, keeps things consistent, and makes it easy to remember. That’s why the profit first system utilizes the 10/25th rule. This rule will tell you to pick two days per month where you dedicate to reviewing your finances.
The Profit First for Chiropractors book recommends that you set the 10th and 25th of every month as your dedicated financial day. However, you can pick two days more conducive to your schedules, such as the 1st and 3rd Thursday of the month. Ultimately, it’s not the days you choose that matter, and it’s the fact that it works for you and you are doing it consistently.
By implementing the Rhythm, you are setting expectations for when you will review your finances. You don’t have to worry about them on the other days because you know that you will be reviewing everything and determining how you are performing on your finance days.
Another great thing is that you are now reviewing your finances twice per month, not at the end of the month, quarter or year. You will see changes as they appear in your finances, and you will be able to take action to amplify positive results or adjust course if things are not going how you would like them to.
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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