Profit First System – Mike Michalowicz

Step 1: Set up multiple bank accounts and allocate them funds based on percentage.

• Typically, businesses only have one bank account set up. When money flows in this sole account, we usually use the value in it almost instantly to address our next apparent or urgent issue. This leaves us blindsided for the other minor business stuff that needs attention as well.
• Profit First suggests that you set up five foundational bank accounts (one main account, four sub accounts) namely:
  • Income Account (trading account) - this will serve as your main account and this account is where you’ll mainly accumulate money. It should act like a serving tray that caters to the other accounts.
  • Profit Account (shareholders) - this account is to store the fund you’ll use to reward your shareholders; money allocated in this shouldn’t be pushed back into the business.
  • Owner’s Compensation Account (owner’s salary) - this is where the business owner’s consistent salary should be allocated, and it is different from your Profit account.
  • Tax Account - this account is solely for your tax liability.
  • Operating Expenses Account - this is where your residual money should go to keep the business operating.
• Consider the Owner's Compensation account as your lifestyle and the Operating Expenses account as the business’ lifestyle.
• Once you’ve set up these accounts, determine what percentage should you sub accounts have.
• Take note that percentage allocation will vary depending on many factors such as the size of your business.
• If your business keeps struggling on your allocated fund, this means that there is something that needs to be adjusted in your business.
• Let’s say you’ve allocated 60% of your total income towards Operating Expenses but you seem to be struggling to pay your bills, this suggests that your business is communicating with you. You need to look at fixing your business, so the above numbers work.
• Remember that if your business is not profitable during the early phases, you can cut down the percentage allocation on your profit account, for example, and reallocate the funds to your operations expenses account. Start slow and start to grow.
• This system can work for any size business as it is percentage-based.

Step 2: Determine your allocation frequency and sequence.

• Determine the most suitable frequency that you will allocate your cash from your trading account to the other four accounts (weekly, fortnightly).
• Take note that you should only use the money currently sitting in your sub accounts when paying your bills. The money that’s accumulating into your main income account that are yet to be budgeted and allocated shouldn’t be spent for your bills. This way, you will determine, and possibly avoid, any cashflow traps in your business.
• There is a reason why Profit First suggests allocating all your earnings in a specific sequence: you start seeing profit accumulate over time.
  • It establishes a powerful reward mechanism for the first two sub accounts (profit and owner’s compensation).
  • The tax account, on the other hand, serves as protection.
  • Lastly, your operating expenses account is what serves your business.
• Every time you do the sequence, it hints excitement and demonstrates ‘financial muscle’.

Step 3: Remove any temptation.

• Avoid pulling funds from your other sub accounts to spend for another purpose — consider it stealing from yourself. This unwinds the entire system.
• One of the most common mistakes, as based on Mike’s experience, is misspending funds from your profit account and using it for operational expenses.
• You can avoid doing this by removing your means to give in to any temptation. Simply avoid or minimize access to your profit account. Make it inconvenient to access your profit account like using another bank.

Step 4: Get into the rhythm and stick to it.

• This step is simply about having an established business that is not reactionary.
• There are three key process to get yourself in the rhythm:
  1. Get used to your allocation frequency.
  2. Establish a profit distribution frequency.
     • Mike suggests having a quarterly profit distribution. Every quarter distribute 50% of the balance of your profit account to shareholders.
  3. Determine when your taxes are due.
• When you’ve gotten into the rhythm of your allocation sequence, your business will be able to avoid having ‘peaks and valleys’ and become more established.

Supporting Notes

• Keep track of your expenses and document them.
• Evaluate your business expenses every 90 days.
• Identify any expenses that your business isn’t utilizing or one that doesn’t prove to be of any benefit. Once you’ve identified these:
  • Remove that expense.
  • Commit to it and make use of that expense.
• One aggressive way to minimize your expenses and to avoid overspending is to cancel your credit card.
• Cutting your business expenses isn’t the only way to maximize profit. You may also perform an evaluation opportunity where you look for ways to amplify and increase your margin.
• Eradicate and stay out of debt as much as possible.