3 Signs You Should Adjust Your Profit First Allocations
Businesses of any size can benefit from following the Profit First method of accounting and bookkeeping. It’s appropriate and helpful for everyone, from solopreneurs to large multinational corporations. Once you have this system set and running, it’s important to watch for signs that it’s time to adjust your Profit First allocations.
Fisher Bookkeeping offers certified Profit First coaching and bookkeeping. We believe in it so strongly that we use it for our own business! With experts in Portland, OR, and near Lexington and Chicago, our team is ready to help yours. Connect with us to learn more about our bookkeeping, CFO, and Profit First services.
Profit First: A Quick Review
If you’ve spent much time on the Fisher Bookkeeping site, you’ve probably noticed that we are big Profit First proponents. As impressive as this system is for helping you meet your financial goals, many business owners aren’t familiar with it yet.
Here is a quick overview of how it works.
Based on Mike Michalowicz’s book of the same name, Profit First (PF) flips the traditional business equation to ensure profitability from the get-go. That is, rather than subtracting expenses from revenue to discover your profit, you embed profit into the equation first.
In this method, you subtract profit from revenue to determine how much you can spend on operating expenses. You will set up and utilize five bank accounts to make this happen:
- Income
- Profit
- Owner’s Compensation
- Taxes
- Operating Expenses
I promise it’s not as overwhelming as it sounds to establish these accounts! Once these are ready, you will regularly allocate all funds from your income account to the others. Typically, this happens every two weeks.
These distributions are based on your company’s allocation percentages. Our Profit First coaches can help you determine the correct amounts based on your revenue and goals.
Following this system allows you to be profitable immediately. It also helps you to be intentional and conscientious in setting your business expenses to protect your profit.
Knowing When You Should Adjust Your Profit First Allocations
In his book, Michalowicz outlines the target allocation percentages (TAPS) based on your Real Revenue number. You determine your Real Revenue by subtracting the cost of materials and subcontractors from your total income.
Many companies are not ready to hit those target allocations on Day One of using this method. That’s ok! The important thing is to establish the accounts and get in the habit of making the distributions every couple of weeks. You can start with smaller percentages and work up to higher amounts.
For example, if your company’s TAP for profit is 5%, you can start with 1% to get going. Profit First is as much a mindset and habit shift as it is an accounting one. Even 1% profit is still profit. Don’t shortchange yourself or think it’s not enough to be meaningful!
Once everything is up and running, it’s important to watch for hints that it’s time to adjust your Profit First allocations. Here are the top three things to look for as your business grows and shifts.
1. Your Revenue Has Changed
In general, businesses set their target allocations based on revenue. Once your revenue shifts up or down significantly, it may be time to adjust your percentages. For example, when you surpass $250k per year, you might raise your operating expenses and profit TAPS but lower your owner’s compensation allocation.
2. You Pay Down Debt
Many business owners mistakenly think they can’t account for profit as long as they have debt. The truth, however, is the complete opposite. By following the PF method, you will build up funds that you can use to attack your debt while still being profitable.
Under this system, you will use your Operating Expense (OpEx) account to make minimum payments toward your debt each month. If there is a surplus in the account, you can tack on that amount, too. Each quarter, put most of your profit account toward your debt until it’s gone!
As you eliminate your company’s debt, talk about adjusting allocations with your Profit First coach. When your debt diminishes and disappears, your operating expenses will probably be lower, so you might be able to increase your profit allocation.
3. You Are Poised To Grow
Growing your company is exciting! However, it also often comes with added expenses, such as a higher payroll. If you know your company is approaching a season of growth and expansion, it could be time to adjust your Profit First allocations.
Hiring more employees, purchasing new equipment, and investing in infrastructure are often necessary as you grow. To account for these needs, you probably should increase your operating expense allocations until everything is in place.
4. Your Tax Situation Changes
When setting up your Profit First system, the target allocation for taxes is 15%. This amount generally holds steady for most businesses. However, solopreneurs may see more fluctuation here as their companies grow. Work with your tax professional and PF coach to determine the correct percentage for your situation.
Boost Your Profit and Your Way of Thinking
A significant part of the Profit First plan is how it shifts your mindset. Many business owners live in feast-or-famine mode until suddenly, that doesn’t work anymore. With PF, however, you become an empowered, financially aware entrepreneur. The mental boost that comes with knowing you are profitable is tremendous!
Operating under Profit First helps you make spending choices that are thoughtful and intentional because you must work within the parameters of your OpEx account. If this fund doesn’t have the money you need, then you’ll have a clear reason to lower your costs, raise your prices, or both to ensure profitability.
The Fisher Bookkeeping team can really geek out over Profit First, and we are here to help you succeed with this system. Connect with us today to learn more about our services.
About the Author Barb Fisher
Barb is the CEO of Fisher Bookkeeping, an outsourced bookkeeping consultancy that provides small businesses with a full-service financial department. Her favorite aspect of work is to break down the accounting to meaningful bits, so entrepreneurs can make a powerful difference in their own business. She's also a power lifter (squat: 215, DL: 270).
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