A little disclaimer before you dive into this one – I’m not a financial or legal expert, I’m just sharing what I’ve learned using the Profit First principles in my business! I also realize that we all have different financial situations, so I want to encourage you to find what will work for you in this!
“It costs money to make money”
I’m sure as business owners we’ve heard this one a couple of times, and I remember early on in my business feeling this struggle of wanting, or feeling like I needed to invest in all the things, but also being in a stage of business where the income was growing, and maybe not always there. Investing in my business often meant not paying myself, and during the side hustle days that was fine.
I technically didn’t need to pay myself.
It seems like we all fall into one of two categories when it comes to the money side of our business early on:
Leave it all in the business for a rainy day
Pocket it all right away
I realize there might be some in betweens here, but those are the big ones, right.
I found myself in that first category. I really wasn’t paying myself at all. And I was honestly really confused about how to even go about it. I left all the money in the business to pay for subscriptions and business expenses, and anything else just sat there. I really didn’t have a method or system for it all.
But let me ask you this. How long would you keep working somewhere else for free?
How long would it take before you felt a little over it, and maybe a little discouraged if your boss just kept promising you that “oh yeah, I’ll pay you soon. Maybe next month”
And when you do finally pay yourself, don’t even dare trying to see what you’ve actually been making hourly, well cause nothing would be more discouraging than that.
I remember reading a blog post about this around that same time. Look at your working conditions in your business. What you’re expecting of yourself, how much you’re getting back, and how much you’re getting paid.
Is this really what you signed up for?
So obviously, I knew there had to be a better way.
And it was around this time that I first heard about Profit First. And once I read that book, it truly did change everything for me.
I’ve been running a modified version of profit first in my business since late 2019, so today’s episode I wanted to share everything I’ve learned so far, and how I’ve been able to make it work for me.
Oh and if you’re not familiar with it already, Profit First is a book that teaches you some of the principles of how to manage your money in your business, making sure that you’re actually profitable and building a sustainable business.
What is profit first
I’d strongly recommend reading the book if today’s episode intrigues you at all. While I’ll explain how I apply the principles in my business, understanding the why, which the author is way better at then me, will really help you use this successfully in your business.
I also like to say here too that I don’t follow it to a T. In fact, I’ve modified it quite a bit to work for my business, but knowing the rules has really helped me break them well here.
The principle behind Profit First, as the title suggest, is that so often, as business owners, we pay ourselves last. We focus on building the business, buying what we think we need, and then whatever scraps are left over at the end of the day we’re able to take home.
But if you want to run a profitable business, you have to be the one to take charge, right.
Honestly, if you want to run a business at all long term you need to be profitable. According to teh book, 8 out of 10 businesses fail and the number one reason they do so is because they’re not profitable.
And if I’m gonna be honest with you. If you’re not really profitable, or if your business is costing you money, then you might actually have a hobby on your hand rather than a business.
Not that there’s anything wrong with a hobby, but they sure are different.
You can’t just let your business and bank account dictate what kind of investments you should make, and while it’s great that we get to get paid to be creative, we do also have to make money doing it.
I’m sure we’ve all been in that situation where we see a course or product or new equipment that we want, and perfectly enough the cost or investment exactly matches up to what your client just paid you.
You’ve got the money, so why not just spend it.
So you do.
And then your supposed payday comes around, and there is nothing left for you. Because youve already spent it all.
So then you think to yourself “oh, this must be a problem in my business. I’m not making enough money. I need another course or program to help with that” So you find one. And you do the same thing again.
And once again, there is nothing left for you at the end of the month.
As business owners, we have to learn to put our profit first, and then build the business around that, rather than the other way around.
So the regular way of doing accounting encourages us to look at
Sales – expenses = profit
With profit first, we’re changing things around and it should now look like
Sales – profit = expenses
Does that mean I don’t spend money on my business?
But it means there’s a very clear plan that helps you act strategically and confidently make decisions about your finances as a business owner.
And I also have to add here, running profit first in my business was one of the main reasons why I was able to not worry so much about this aspect of my business when the pandemic hit. And I realize that’s not the case for everyone, but I wanted to point out that having these systems in place in my business has brought me a lot of peace during the past year.
Separate your personal and business finances
So now that we understand the principles behind profit first, I want to talk about how it works, but before doing that I want to encourage you here if you don’t already have a separate bank account for your business, that is definitely step one here.
You need a bank account, not just for bookkeeping sake, but also for potential liability and the mindset thing that you are showing up for yourself and your business.
How does profit first work?
So how does profit first work?
It encourages you to separate every transaction that comes into your business into buckets.
My favorite thing here is that it is set up to work with how us humans actually operate, realizing that a lot of us will look at our bank account balance to determine if we have money for something (referred to as bank balance accounting) rather than knowing our numbers before making decisions.
Because of this, the author wants you to set up four separate bank accounts. One for each of these buckets.
The buckets or accounts that you want to have in your business are:
- Owners compensation
- Operating Expenses
And each of these gets a set percentage every time. The standard starting point is 50% owners compensation, 5% profit, 15% taxes, and 30% operating expenses.
So let’s say someone just paid you 1000 dollars.
You would divide that up as:
- 500 dollars would go to your owners compensation account,
- 50 to profit,
- 150 to taxes and;
- 300 to operating expenses.
So when you go to pay yourself at the end of the month, or biweekly, however often you do that, instead of seeing your entire bank balance, wondering how much you can pay yourself and how much you need to save for taxes, you’ll just look at the amount that is in your owners compensation account.
It makes it feel way less difficult when you do have to pay your taxes or anything else like that, because that money was never really yours. And for me, I’ve noticed that it made investing in my business less personal. Because I’m not choosing whether I want to pay myself or invest, I’m allowing myself to do both but in a strategic way.
Profit First and YNAB
So I mentioned earlier that I do a modified version of profit first. And I actually heard about this for the first time from Paige Brunton.
I grew up with a mom who had a separate bank account for almost anything it seemed like. Income landed i one account, savings in one, bills from one, etc. It was almost how I was raised so profit first definitely made sense to me. But I’ve found that after I moved to the US a lot of these come banks come with fees or balance minimums, and the way profit first works, that just dind’t really make sense to me.
I definitely know you can shop around and in some cases find banks with no minimums, but I actually love my bank and wanted to stick with them. So I wanted a different solution.
And I found that through Paige and her recommendation for the app, You Need a Budget.
The reason profit first recommends multiple accounts is to remove that temptation of bank balance accounting, but if you know yourself and know that that isn’t a likely problem for you, I’ve found YNAB to work great for this.
So how does that work?
YNAB is budgeting app, which is essentially what we’re doing. It’s connected to my bank account, which makes it super easy for me to update.
Once a payment lands in my bank account, it will show up in YNAB under the “to be budgeted” category. From there, I have a tab as part of my financial spreadsheet set up with the percentages so I just type in whatever the number was, again say 1000, and it spits out the exact numbers I need.
I’ll just type in each of the four and tell it what category to go to, and then move on with my day.
Then, if money goes out of my account, I make sure it’s being pulled from the right budget in YNAB.
So if I just paid an expense, that will get deducted from the operating expense balance in YNAB.
Because my income like a lot of creatives fluctuates, I’ve set up a separate system, which is totally not necessary, but I never pull the entire amount in my owners compensation bucket every month.
I pay myself monthly, because again that’s how I grew up and I truly dislike the biweekly paycheck thing in america. So around the first of the month, I’ll look at how much is in my owners compensation account, divide it by three, and then pay myself. This way I know that if something happened, I have enough money to pay myself for three months basically without any new projects or income, and it brings a lot of peace of mind.
The book says to pull your profit account balance every three months, and then use that for something fun (or whatever you want really) but kind of like a bonus if you had a regular job.
I’ve used mine in the past to buy myself rewards or milestone celebrations in my business. I’ve also used to to fund my retirement account or pay of student loans, but early on, he does encourage you to celebrate with this money, even if it’s just buying some ice cream.
You’re working hard. And you should reward yourself for that sometimes.
So what happens if your expenses exceed the balance in the operating expense account?
In that case I recommend reviewing your current expenses, are there any that can be removed? I’m a big believer in running a lean business and not just signing up for all the things we think we might need, so reviewing this could be great for you as well. If you can’t find anything there to cut out, you might need to make more money or adjust your expectations to be able to cover your expenses!
The biggest thing here is that profit first allows you to take control, to know your numbers, and to make informed decisions about your business as the CEO of your company.
You Need A Budget (get started with a month for free!)
*this post contains affiliate links, which means I might get a financial kickback if you purchase from the links at no additional cost to you!