One thing I find myself reminding people of over and over is that profit is not an event—a one-time, “Hey, I did it!” kind of thing that happens at tax time, if you’re lucky. To make real profit, consistently, it has to become your habit. Like anything else, if you have a plan and stick with it, and repeat it on a regular basis without fail, it becomes second nature to you. And thus, your profit is born!
WHY Does Profit First Work?
The short answer is that Profit First, created by Mike Michalowicz, works with our existing behavior and provides a framework to manage financial activity in a manner that builds in profitability. The longer explanation is found in the “law” that governs this existing behavior, called Parkinson’s Law, developed in the 1950’s by C. Northcote Parkinson, a British Naval Historian. Parkinson proved that the consumption of any resource (including time and money) will rise to meet the quantity of the resource available.
Because of Parkinson’s Law, the old business equation Sales – Expenses = Profit is destined to leave us with little left over. The Profit First equation is Sales – Profit = Expenses. As you know, the math works either way. But from a behavioral perspective, if we don’t take our profit first, there will be none left over as our expenses will rise to meet our income. In addition, if you do take your profit first, the funds left over for operating expenses will be less. This puts pressure on you to operate efficiently and frugally, and to be more innovative. If you’re not operating in this manner, you can be sure that at some point a competitor will be.
HOW Does Profit First Work?
Step 1 – Creating multiple bank accounts sets you up for success by separating your cash into bank accounts created for specific purposes. Most businesses operate with a single business checking account for all business activity. For Amazon sellers, I suggest starting with a checking account for inventory and another checking account for operating expenses. In addition, savings accounts are used for Profit, Owner Pay and Taxes. If you’re just getting started, I recommend starting with three accounts: Inventory, Profit and Operating Expenses. Once you understand the system, you can expand by adding the Owner Pay and Tax accounts. As you separate your cash into accounts for specific purposes, you may lose some of the float associated with your inventory purchases. Be sure to watch it closely.
Step 2 -Following a prescribed sequence creates a new behavior around the new bank accounts. As your Amazon or other income is deposited in your operating expense account, you will move the funds into the designated accounts based on a specific sequence. First, look at the costs of the products you just sold. If your income deposited after fees is $50K, look at the costs of the products you sold to generate that $50K. Typically we see the product costs of about $20K. Transfer the $20K into your inventory account. This account will be used to pay for replenishment inventory. Next, move 1 to 5%, whatever your cash flow allows, into the profit account. In this way you will be profitable with your next Amazon settlement. You are setting up your business to ensure that profit is a habit, not an event that you anticipate at tax time.
Finally, the remaining amount will stay in your operating expense account. Look at your expected expenses coming due before your next Amazon settlement and make sure you can cover them with the remaining funds. If not, you should look at what you can cut or reduce. Initially you may need to use the lower percentages for the Profit Allocation. However, if you cannot cover your operating expenses, it is a signal that you may be living beyond your means.
Step 3 – Removing temptation is based on the realization that new behaviors are hard to learn and maintain. If a growing balance in your Profit Account is going to tempt you, then move that money to an account that is less accessible. Some of our clients customize their online banking profile to hide their profit account from view. Others transfer the funds for the profit account to another bank. Transfers from an account at another bank require more hoops to jump through and a few days to access the money. This gives you time to contemplate how you may be propping up your business with these funds. If you are committed to making this work, and have the discipline to leave these funds alone, then a separate account at your primary bank will work fine. You know yourself, be honest and set yourself up for success.
Step 4 – Implementing a Rhythm optimizes the time you will spend managing your funds. To truly understand the flow of cash, you should fund the accounts as prescribed in Step 2 every two weeks. Most Amazon sellers receive payouts biweekly, so this rhythm already exists. Fund your accounts following the sequence, then pay any bills due before the next payouts. If you’re using credit cards and auto withdrawals, look at the upcoming payments and ensure that you will have the funds needed.
After you have gone through this process for a few months, you will start to understand the rhythm of your business’ demands for cash. You can develop a shortcut for the allocation process by determining the average percentages that are needed to fund each account. When you receive a payout from Amazon, you can simply apply the percentages to the funds received and make the transfers based on that calculation.
Implementing Profit First in your business can help you reduce worry and stress, and create a business that supports your life instead of running it. Need help getting started? Reach out to the bookskeep team. We’re here 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!