We’re all creatures of habit, and when you’re a business owner with a lot on your plate, falling into the habit of pushing things off until that last-minute during tax season can be pretty easy. However, when it comes to making a real profit continually, procrastination isn’t going to cut it. You need to be consistent and commit to regularly repeating these actions until your bad habit is a thing of the past and the new habit of profit now stands in its place!
What Makes Profit First Work?
Profit First, created by Mike Michalowicz, is designed to work with behaviors we already have and gives you a financial management framework that can build up your profitability. The basic theory comes from Parkinson’s Law, created in the 1950’s by C. Northcote Parkinson. In this “law” Parkinson determined that consumption of a resource, time and money included, will rise to meet the quantity of that resource that is available. In other words, if you have it, you will use it.
With Parkinson’s Law in mind, the usual equation of Sales – Expenses = Profit is more than likely not going to leave an abundance of money. Profit First’s version of the equation is Sales – Profit = Expenses. From the mathematical perspective, the equation can work either way, but our behavior will prevent us from making a profit unless we take it out first, because our expenses will increase to match the profit. On the reverse side of it, taking profit first means there will be less left for expenses. This means you will have to start operating more efficiently and economically to stay ahead of the competition.
How Profit First Works?
Step 1 – By creating various bank accounts, you are set up to separate cash into accounts made for specific purposes. Many businesses run with a single checking account for all of the operations. For ecommerce sellers, we recommend beginning with two checking accounts, one for inventory and one for operating expenses. Additionally, savings accounts are for Proft, Taxes, and Owner Pay. If you’re just starting out, I suggest three accounts: Inventory, Profit, and Operating Expenses. When you have a better understanding of how the system works, the Owner Pay and Tax accounts can be added. Be aware that as you move your cash into the separate accounts, you might lose some of the floats that come with inventory purchases, so be sure to keep a close eye on it.
Step 2 – A prescribed sequence can help establish new behaviors when it comes to your new bank accounts. You will start to move money to the designated accounts in a specific sequence as Amazon or other income comes in to your operating expense account. You should look at the cost of products you recently sold. If your deposited income after fees is $50K, look at the cost of products sold that generate the $50K. We normally see products costs of around $20K. You should move the $20K to your inventory account, which is for purchasing inventory replenishment. You should then move 1 to 5%, based on what your cash flow allows, into your profit account. By doing this, your next Amazon settlement will be profitable, because you have set your business up to make profit a consistent habit.
You will keep the remaining amount in the operating expense account. Review your expected expenses due before your next Amazon settlement and ensure that the remaining funds will cover them. If they won’t, you should consider things that can be reduced or even cut. In the beginning, you may just have to use lower percentages for your Profit Allocation. If you can’t cover the operating expenses, however, it is an indication that you could be living beyond your means.
Step 3 – Removing temptation is focused on understanding that it can be hard to learn and stick to new behaviors. If an increasing Profit Account balance is a temptation, move the money to a less accessible account. Some of our own clients use a custom banking profile to hide the profit account from their view. Some others move the profit account funds to a different bank since transfers between banks have more obstacles and can take a few days for the money to be accessible. You then have time to reflect on how you may be propping up your business with these funds. As long as you are committed to the process and are disciplined enough not to touch your funds, an account at your primary bank is fine. Be honest with yourself and set yourself up to succeed.
Step 4 – Implement a Rhythm maximizes the time you will have to work on managing the funds. In order to really understand the flow of your cash, you should be funding the accounts according to Step 2 every two weeks. Most sellers receive biweekly Amazon payouts, so the rhythm is already there. Follow the sequence to fund your accounts, and then pay bills that are due before your next payouts. When using credit cards and auto withdrawals, look at your upcoming payouts to be sure you will have the money needed.
After a few months of implementing this process, your understanding of the rhythm your business requires for its cash demands will increase. Shortcuts can be created for your allocation process by finding the percentage averages you will have to have to fund your accounts. After receiving Amazon payouts, you can just apply the percentages to your funds and make transfers using that calculation.
Through Profit First, you can decrease worry and stress around running your business and build a business that will work for you instead of you working for it. If you need help getting started, reach out to the bookskeep team. We would love to help!
Interested in Profit First?
If your ecommerce business isn’t where you’d like it to be in terms of profitability, check out my book, Profit First for Ecommerce Sellers. It answers important questions about how to implement Profit First in an ecommerce business. Take control of your money and your business, and put Profit First to work for you!
You can also sign up for the Profit First for Ecommerce Sellers Online Course. As a Mastery Level, Certified Profit First Professional, I will teach you why Profit First works so well for ecommerce businesses and the particular challenges for businesses that have physical products requiring inventory management. You will learn how your behavior drives your money management habits for your business and how you can set up your business bank accounts to work with your habits.
Check out all our ecommerce accounting and profit advising services here!