Transform Your Business from a Cash-Eating Monster to a Money-Making Machine
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Profit First offers readers a new way of considering accounting. Instead of calculating your profit based on the difference between your sales and expenses, Mike Michalowicz suggests calculating your expenses from the difference between your sales and profit. Take your Profit First, then work out how to cut your expenses. Mike developed this idea from the most effective weight loss strategy – limiting portions by using smaller plates. Mike Michalowicz’s system aims to turn people’s businesses from feeling like cash-eating monsters into feeling like profitable cash cows.
Mike Michalowicz’s Perspective
Mike Michalowicz is a former small business columnist for The Wall Street Journal. Additionally, he used to be a makeover specialist on MSNBC. Mike is now a popular keynote speaker on innovative entrepreneurial topics. Plus, he is the author of multiple books: Fix This Next, Clockwork, Surge, The Pumpkin Plan, and The Toilet Paper Entrepreneur.
Chapter 1 – Money Problems Are Tied to Sales Speed
Mike starts the book by explaining that money problems arise when one of two things occur:
- Sales slow down – There are obvious problems with sales slowing down. Firstly, it can make paying expenses and employees a challenge. Plus, it makes it difficult to scale up your company.
- Sales speed up – There is a tendency for people to believe that a quick rise in sales is good. However, there are problems associated with sales speeding up. As your income climbs, your expenses will also rise quickly. Additionally, companies will start spending more after a huge spike in sales. However, the reality is that drought periods will almost certainly come just as quickly. Then, if your expenses have also increased, you could have a significant gap in your cash flow.
Hence, Mike suggests that the perfect size for your business is the size that develops naturally. Do not try and force development by increasing expenses significantly after one rise in sales. Instead, fix your profit first and then grow. Identify the things that help you make a profit and dump the things that don’t make you profit. Focusing on growth will leave you trying to do whatever it takes to grow. Focusing on profit will help your company develop stability, sanity, and longevity.
Chapter 2 – The Core Principles of Profit First
“The old, been-around-forever, profitless formula is: Sales – Expenses = Profit The new, Profit First Formula is: Sales – Profit = Expenses The math in both formulas is the same. Logically, nothing has changed. But Profit First speaks to human behavior—it accounts for the regular Joes of the world, like me.” – Mike Michalowicz
Mike outlines several core principles of putting profit first:
- When less money is available to run your company, you will find ways to get the same or better results with less input. Taking your profit first will force you to think smarter and innovatively.
- Adopt an out of sight, out of mind approach with your profits. In essence, from today, you need to tell yourself that you will move any profits away from immediate access. Mike explains that you won’t access and waste your profits if you can’t see them.
- Become the best in one area of what you do. Becoming the best in one field will allow your company to grow far bigger and faster than you can imagine. Therefore, Mike suggests that you first identify your strongest skill and become significantly better at this skill than you currently are.
- Adopt a simple new accounting formula. This system will be based around a profit first system of Sales-Profit=Expenses.
- Eliminating unnecessary expenses will help your business more than anything else.
- Create a separate bank account with the name ‘profit’ and pay one percent of every standard checking account deposit into your ‘profit’ account.
Chapter 3 – Setting Up Profit First For Your Business
Mike already introduced the idea of a separate account called ‘profit.’ However, Mike recommends that you should set up five checking accounts at the start of your business:
- Owner’s Comp
Mike also suggests that everybody opens two more external savings accounts. Ensure that these accounts are with a different bank than the one you use for your daily operation. One of these savings accounts will be your no-temptation profit hold account. The second savings account will be your no-temptation tax hold account. You should ensure that both of these accounts can directly withdraw money from your respective checking accounts. Additionally, Mike suggests that you set these accounts up so that you cannot view the balances online. The rationale behind this is that you will deposit funds and then forget about them. Having these savings hidden from view will help your business become more profitable.
Profit First also involves adopting a systematic approach. Therefore, you should also make sure you do the following on every 10th and 25th day of each month:
- Pay your bills
- Move funds to various accounts
- Get a feel for where your money really goes
Tracking your finances like this should provide you with further motivation. Additionally, you should also pay yourself a dividend on the first day of every new quarter. Mike suggests that you take fifty percent of the money in your profit account as your dividend. You can spend this money on something you and your family will love as a celebration. By doing this, you will stop viewing your business as something that is just a cash-eating monster. Instead, you will be viewing your business as a cash generator that is giving back and supporting you.
After the balance of funds in your profit account can cover three months of fixed expenses, you should start investing it. Specifically, start using these funds to make capital investments. Making these sorts of investments will continue to boost your productivity so that you can invest even more.
Chapter 5 – Allocation Percentages
“Working on your business is about building systems. Period. An entrepreneur is someone who finds the solutions to opportunities and problems and then builds systems to consistently deliver those solutions through other people or things.” – Mike Michalowicz
As well as opening specific accounts, it is also crucial that you know how to distribute the profits accordingly. Mike explains that you have to be the one to decide for yourself what numbers make sense for you and your business. Despite this, he provides guidance on how you might start deciding where to allocate your money.
- Figure out where you and your business are right now. Enter your Top Line Revenue for the last twelve months. After doing this, deduct all payments for materials and subcontractors. This calculation should leave you with your Real Revenue.
- Look at how your Real Revenue is distributed. Enter your actual profit from the last twelve months, as well as how much you paid yourself, how much tax you paid, and what your operating expenses were. After writing each of these figures down, you should then aim to work backward. Express each of these figures as a percentage of your Real Revenue.
- Compare your current distribution of proportions with your target distribution of proportions. Your target percentages should consider the fact that your enterprise is at a particular stage in its growth. Subsequently, as your company grows and adds more employees, you will also alter your systems. For example, you will adjust your pay down as you transition from being an employee to being a shareholder. Additionally, as part of this transition, you will most probably add a management team.
- Decide what you need to fix. Try and compare your current allocations with your target rates and decide on specific fixes to move forward. Hence, Mike suggests that you decide to either write ‘Increase’ or ‘Decrease’ on your report at this stage of the process. This decision should be made depending on whether you should be increasing or decreasing your revenue allocation. Do this for every area of your business.
Mike concludes this chapter by stating that your company runs more efficiently if you have a larger profit allocation percentage. The higher the percentage, the lower your operating expenses. Finally, Mike suggests that you set your CAPs one percent better than you have historically. In essence, this means you are increasing your profit, owner’s comp, and tax by one percent. Simultaneously, you will also be cutting your operating expenses by three percent.
Chapter 6 – Putting Profit First Into Motion
Mike describes two ways of putting Profit First into motion. Specifically, you need to either increase sales or cut expenses. Increasing sales is possible, but it does take time. In contrast, cutting expenses is generally a swift and easy process. Here are some tips provided for putting Profit First into motion:
- Tally the amount of profit in your account (don’t add any quarterly distribution percentages from deposits you received today). Then, take fifty percent of the money as profit. The other fifty percent should remain in the account as a reserve.
- Your reserve should be a three-month cash reserve. This should contain enough cash to operate your business unscathed for three months if your sales came to a complete halt.
- The profit account is where your reserve should accumulate.
Chapter 7 – Destroy Your Debt
It is all well and good improving your profits, but if your company is still in debt, you might not be seeing much of these profits. Mike describes debt as the biggest obstacle to putting Profit First. In the first place, try and minimize debt by never basing your financial decisions on your best revenue month. If you do this, you will run out of cash very quickly and start to accumulate debt. Making decisions based on your best revenue month encourages you to survive rather than thrive.
Plus, try and start a debt freeze. Mike explains that a debt freeze involves stopping any recurring payments and killing off anything you and your business don’t need. You should be aiming to get your monthly nut down to ten percent below what your Instant Assessment suggests it should be.
To remove debt, Mike suggests that we take successive small steps heading in the right direction. Over time, these small steps will make a big difference. Plus, these small steps will be far more comfortable than trying to make massive, dramatic changes. Build momentum and keep moving forward. Here is an example that Mike provides of small steps that you might try and take each quarter:
- Increase profit by 3%
- Decrease operating expenses by 5%
- Increase owner’s salary by 2%
Chapter 8 – Find Money Within Your Business
Mike provides readers with a massive goal. He wants you to investigate every aspect of your business and make the changes that will help your business get double the results with half the effort. However, Mike provides a series of tips that can help you find more money within your business.
Build a Leaner Team
The area where you will likely be spending most of your money operating your business is labor. Therefore, you should look at your team and ask yourself the following questions:
- Who are my most important employees? Which employees provide the business with a net positive?
- Which roles need to stay in-house?
- Which roles are no longer profitable and can be removed?
- Which roles could I take on personally until profits increase?
After being honest with yourself, you may identify that you are currently overstaffed based on your company’s revenue level. If this is the case, you may have to plan to lay off those not included in your answers to the first bullet point. Then, outsource any work of theirs that you still need doing. Laying people off is not a pleasurable experience. However, creating a lean team is vital for future profitability. During this process, Mike recommends talking to your attorney and ensuring that you comply with the relevant labor laws by laying people off.
Get Hands-On With Your Funds
You need to be on top of your funds at all times. Hence, you should call your bank and cancel all automatic withdrawal from all of your accounts. You should be actively making decisions about what you are doing with your money, dependent on the business’ state at that time. Additionally, Mike recommends calling your card issuers and asking them for a new card with a new number. Then, see which vendors call you for your new card details. Most people have recurring charges that are running in the background that are forgotten. Changing your card numbers will let you take back control of your funds.
After taking control of your automatic expenses, you should try and renegotiate your essential monthly expenses. Try and see if your vendor can reduce your bill by 25% each month. If the vendor cannot help, see if there are cheaper alternatives that can do the same job. Check this frequently, as new deals can crop up.
Start a Debt Snowball
You can start a debt snowball by first listing all your debts. These debts should be in order from smallest to largest, regardless of interest rates. Then, you should pay the minimum on all these debts except for your smallest one. Wipe out this first debt as quickly as you possibly can. After paying off this first debt, you should move onto the second debt. Pay off this second debt as you did with the previous debt, and add the amount you had to pay off on the first debt. Carry on this process until all your debts have been paid off.
This approach to paying off should create a debt snowball, which is driven by momentum. By starting with your smallest debt, you can build up to larger accomplishments over time. Importantly, though, do not add any further debts while paying off these debts.
Sell More Productively
To sell more productively, you will have to learn to sell smarter. Learn what works for you and your business, then implement this approach into the business’ system. Subsequently, this approach will be adopted by everybody involved in your business.
After this, you should aim to fine-tune your sales system. This fine-tuning will take time, so start improving it now and progressively make improvements. Also, try to make improvements to yourself. Therefore, become very good at what you do and always focus on becoming even better.
Duplicate Your Best Clients
“All revenue is not the same. If you remove your worst, unprofitable clients and the now-unnecessary costs associated with them, you will see a jump in profitability and a reduction in stress, often within a few weeks. Equally important, you will have more time to pursue and clone your best clients.” – Mike Michalowicz
One of the most effective ways of boosting your profits is to avoid your worst clients and find ways of duplicating your best and most profitable clients. Mike describes the Pareto Principle as being hugely crucial for duplicating your best clients.
The Pareto Principle is also often called the 80/20 principle. This principle explains that twenty percent of your customers will generate eighty percent of your profits. Therefore, you should aim to eliminate your worst clients and replace them with your best clients (the 20%). Mike also reinforces that eighty percent of your profit will be derived from twenty percent of the products or services you offer.
There are many approaches you can take to duplicate your best clients. For example, you can encourage your bad clients to buy more. Alternatively, you can attempt to get your best client to buy more profitable services or products from you. Finally, you can look for customers who have similar needs and behaviors to your best clients. Streamline your company so that it excels at meeting the specific needs of these clients. Becoming passionate about serving your best client will help make your marketing toward these ‘best clients’ more automatic.
Chapter 9 – The Advanced Techniques
As a foundation, Mike suggests that your company should be generating real revenue of 150,000-250,000 dollars per full-time employee. However, many more advanced techniques should also be adopted to start putting Profit First.
Give your self-discipline an extra boost by starting an accountability group. These groups should include like-minded peers who meet regularly to swap ideas and keep each other on track. Knowing you will have to report back to the group will increase your odds of following your goals.
A profit pod is where you teach others the Profit First principles and then help them apply them. You form a group of people going through the same transformation and then start providing hands-on help to each other. You will always learn more from teaching, so this is an excellent opportunity to help others while also helping your business.
Chapter 10 – The Profit First Life
Mike outlines five primary rules to help you stay in the Profit First lifestyle for the next five years:
- Always start by looking for a free option
- Never buy new when you can buy something equally good that is used
- Never pay full price if you can avoid it
- Negotiate and seek alternatives first
- Delay major purchases until you have written down ten alternatives to making the purchase and have thought through each one
- Save your spending for your Profit First quarterly dividends
You should only gradually upgrade your lifestyle as your income increases. Mike calls this the Wedge. Also, every time your income increases, you should set aside half of the increase as savings.
Final Point – Teach Your Children to Profit First
As well as benefiting from profiting first, you should also pass this knowledge on to your children. Therefore, try and instill good spending habits very early on in their lives. Mike suggests that you give each of your children five envelopes and label each of them this way:
- Envelope #1 should be called the ‘Big Dream.’ This envelope should be for something big they want in the future. Have your children stash away 25% of their chore or gift money into this envelope.
- Envelope #2 should be called ‘Family Support.’ Each of your children should pay something each week to contribute. They can choose what they want, but you should set a minimum.
- Envelope #3 will be called ‘Impact.’ Have your children put approximately 10% of their income into this envelope to give to a charity of their choice or to start their own business.
- Envelope #4 is ‘The Vault.’ Your children should put 10% of their funds into this and hope that they never need this. However, this will teach your children to prepare well.
- Envelope #5 is called ‘Mad Money.’ Your children can use the remaining money to buy whatever they want and have fun.
Teaching your children to allocate money in this way will instill good habits from a young age.
We rate this important book for business owners 4.5/5.
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