Businesses exist for many reasons—to provide goods or services, to fill a need, to address consumer pain points—but ultimately, they exist to make money. As such, it’s alarming how many smaller companies actually aren’t generating as much as they should. They may make revenues, but they don’t necessarily save any of that money in the bank as pure profit. The effect on the business owner is a constant feeling of treading water; never going under, but also never feeling like the business is growing.
Believe it or not, a lot of this has to do with the business owner’s mindset—and a change in perspective can unlock surprising profits in your company. It’s a model called Profit First, outlined by author Mike Michalowicz in his Profit First bestseller. The book and its insights have revolutionized countless businesses. In this post, we’ll show you how they can revolutionize yours.
The Problem with Your Accounting
There’s a decent chance that your company uses the GAAP accounting model, even if you don’t necessarily know it by that name. This has long been the conventional accounting framework; in fact, that acronym stands for Generally Accepted Accounting Principles.
What it boils down to is this: SALES – EXPENSES = PROFITS. Your revenues, minus your expenses, equal your profits. It sounds right. Mathematically, it checks out. But in fact, it’s nonsense. The way you know it’s nonsense is that so many of the companies that use this accounting formula have no profits to prove it.
The Profit First model inverts this formula just a bit. In Profit First, the math looks like this: SALES – PROFITS = EXPENSES. That may sound like a minor variation, but actually, it makes a world of difference. This particularly makes a difference in the business owner’s behavior.
Understanding Parkinson’s Law
But why does this inverted formula change business owner behavior so drastically? For an answer, we look to Parkinson’s Law, an observation attributed to author C. Northcote Parkinson. He famously stated that our demand for resources rises to meet the supply. That means if a project is allotted two weeks to complete, it will take the full two weeks. If it’s allocated five weeks, it will take five weeks. You get the idea.
Profit First uses this law to your advantage. Here’s how: Rather than paying your expenses first, you start by putting aside some money as pure profit—literal money in the bank. What you’re left with, you use for expenses. Remember Parkinson’s Law: The demand for your resources (in this case, money) adjusts to the supply. When you set aside profit first, you simply learn to do more with less money; in other words, your expenses are minimized.
Just Look at Your Bank Account
If you’re unsure about any of this, let’s come at it from a different angle: bank account balancing.
Frankly, most business owners don’t have the time to read all the different accounting statements that are available to them. This includes balance sheets, cash flow statements, and the list goes on. As such, they resort to bank account balancing. This simply means looking at your bank account and making financial decisions based on what you see there.
Business owners who use Profit First have a big advantage. The difference is that, with a Profit First mindset, you take a portion of your deposits and immediately allocate them to profits. As such, when you look at your bank account balance, you see what’s available for spending after those profits have been claimed, and you adjust your spending accordingly.
Using Your Habits to Your Advantage
One of the great assets of the Profit First model is that it doesn’t really require you to change your habits, rather it allows you to use them more advantageously. After all, simply forcing yourself to become more financially disciplined is a hard thing to do. However, being proactive in setting aside profits each month, then letting your natural spending habits kick in from there, is very doable.
You, too, can learn to use Profit First by setting up some savings accounts, forcing yourself not to “borrow” from your own profits, and ultimately turning your cash-eating monster into a money-making machine. Start thinking in terms of profit first and put cash profits in your business today!
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