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In these economically perilous times, small businesses need to focus on maintaining healthy cash flow without becoming mired in debt. But this is often much easier said than done. Especially when it seems as though money is disappearing from your accounts faster than you can make it.
The Profit First method can help you to improve your company’s cash flow through your approach to accounting.
Pioneered by Mike Michalowicz and detailed in his book, Profit First, this method enables small businesses to improve their cash flow and profitability by rethinking their approach to budgeting and cash flow management.
While it may take a lot of unlearning what you know about managing your business finances, it can help you better take control of your company’s liquidity and make your operations more profitable.
Profit First accounting method explained
In its simplest terms, Profit First is a formula that encourages business owners to put profit at the forefront of their accounting.
Traditionally, business owners use the following formula to calculate their profits:
Sales – Expenses = Profit
The Profit First formula reframes this equation by – well, putting profit first. Profits are automatically deducted from each sale and whatever remains is used to cover expenses. As such, the formula becomes
Sales – Profit = Expenses
While subtle, this shift encourages business owners to be much more mindful of their profit margins and expenses, identifying areas of wasteful expenditure more readily.
How does Profit First work?
Profit First requires businesses to deduct their profits from payments before expenses, instead of paying themselves with what is left over after expenses have been accounted for. It requires you to transfer predetermined percentages of your incoming funds into different accounts in order to cover profits, taxes, overhead costs and your own compensation.
How much is deposited into each account is determined by Target Allocation Percentages (TAPS).
Profit First method percentages
Profit First encourages business owners to think in terms of different percentages. Start out with your Current Allocation Percentages (CAPS). This represents how your revenue is currently spent and serves as a benchmark against TAPS.
TAPS are more aspirational. These focus on how you would like your financial to be split in order to improve your cash flow, ease profitability and fund your business growth.
Advantages of the Profit First method
There are numerous reasons to consider implementing the Profit First method:
Relatively quick and easy to incorporate into your operations
Encourages you to think in terms of profitability rather than revenue
Yields immediate results in the profit section of your P&L statement
Encourages business owners to be proactive in setting the profit margins on products and services
Disadvantages of the Profit First method
As with any accounting method, there are some potential caveats to consider when adopting the Profit First method:
Can be difficult for new startups (who think of profit in terms of monthly cash flow) to adopt
Not all outsourced accountants are familiar with the method
May take time for your team to adapt to Profit First thinking
Implementing the Profit First method
There is no single way to implement Profit First into your operational model. It’s certainly worth reading the book and encouraging the rest of your team to do so, and seeing how its principles can be incorporated into your accounting. There are also a number of Profit First-trained accountants in the UK to choose from.
Identifying money leaks and focusing on profitability can be applied to your operations in a number of ways. For instance, using bank-to-bank transfer as a payment method instead of credit or debit card payments could build more profit margin into every transaction your business makes.
We can help
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