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What is Profit First?
A few years ago, I read the book Profit First. It came highly recommended and initially I really liked the concept. It wasn't until I saw my clients struggle with the concept that I realized I can't recommend this approach to entrepreneurs who want to grow their businesses fast.
Profit First is a popular book and concept by Mike Michalowicz. It's based on the idea that you'll spend the money you see in your bank account for business expenses and there will be nothing left to pay yourself a salary, let alone for profit. Instead, Mike suggests you take out profit first, then your salary, then taxes, and then whatever is left needs to cover your business expenses.
The concept of Profit First comes from Parkinson's Law, which generally says that we will consume whatever amount of something we have. For example, if I have three weeks to prepare a presentation, it will take me three weeks to complete it. But if I have only one hour, I can actually prepare the same presentation—at the same quality—in just one hour.
It's the same when it comes to food. When you have a plate full of food, you'll eat it all and you'll be full. If you have half a plate of food, you'll also eat it all and you'll also be full.
Profit First Principles
The core principles Mike talks about in Profit First are derived from healthy lifestyle habits.
The first principle is using smaller plates. He suggests using multiple small bank accounts, where you put in your taxes, your profit, your salary. You take those away from your main back account so you basically aren't seeing that money. Out of sight, out of mind.
The second principle is eating your vegetables first. When you take out profit first and owners' pay and taxes, you can't spend any of this money on the expenses. You can only spend what's left.
The third principle is removing temptation. By putting all this money away—profit, taxes and salary—you can't really steal from yourself. You can only take whatever is left in your main bank account. Often that bank account is empty so there's nothing left to spend on.
The fourth principle is using a rhythm. Managing your books twice a month so you're always up to date on your cash flow.
When Profit First May be Killing Your Growth
Overall, Profit First is a great idea for small business owners who have trouble managing their cash flow. It's also the perfect approach for businesses that want to stay small and not grow.
It's a horrible idea for entrepreneurs who want to grow their businesses fast.
It assumes that entrepreneurs are like kids in a candy store who can't control themselves. I believe that entrepreneurs who are serious about their growth will know how to manage their cash flow.
When I read Profit First two years ago, I was initially blown away and thought it was brilliant. However, I wasn't interested in applying its concepts myself. As an experienced CEO of 14 years, I didn't feel the need to change the way I did my bookkeeping and accounting. But I thought it would be valuable to share with my clients.
Until I saw it was killing their growth.
Since the Profit First concept is very popular, I was at first careful about voicing my concerns. After brainstorming with a group of multiple seven-figure entrepreneurs, my concerns were confirmed. And I can't recommend this approach to any entrepreneur who wants to grow their business fast.
Read on to see why Profit First doesn't work for fast-growth businesses.
Money is Your Fuel
When you're starting out your business, you have no idea how much money you're going to make. You create a budget but it's not until the end of the year that you really know how much you made.
The idea of taking out profit or your salary in advance is a bad idea. First, you have to prove to yourself that your business can bring in money. Then you need to be willing to take out as a little as possible to build up your business.
Money is your fuel. It's the fuel of your business and if you take it all out there's no fuel left. As an entrepreneur, you need to be willing to invest forward.Money is your fuel. If you take it all out there's no fuel left. As an entrepreneur, you need to be willing to invest forward.
Invest Forward Each Year
In my first year of online business I did many things that contradicted Profit First. I had a virtual assistant, even before I could really afford one. I started to do Facebook ads when I had very little revenue. I hired a business coach for six weeks without having the cash to pay for it. I just put it on my credit card. If I had followed the Profit First principles, I wouldn't have made six figures in 12 months.
Once your business is in its second year, you have a pretty good idea of what's possible. Your budget is now more realistic and you can make predictions about your revenue. You want to grow. You possibly want to double your revenue, so you need to continue investing forward.
In my second year of online business, I continued doing things that went against Profit First. I hired a more expensive and better VA and started to build a team. I paid more for Facebook ads, even in months where things were really slow and I didn't have much money. I invested in several conferences without having the funds to play so big.
If I had followed the Profit First principles, I wouldn't have doubled my revenue in my second year. I wouldn't have gotten to know as many people as I did from all those conferences. And I wouldn't have had the funds to invest further into my business in the third year.
In your third year of business you have a solid idea of what's doable. Your budget becomes even more achievable and you're getting great at managing your expectations. You want to grow more. You possibly want to double your revenue again, so you need to continue to invest forward.
In my third year of online business, I continued to do things that contradicted Profit First principles. I joined my first year-long mastermind and one-on-one coaching program. That was expensive. I put even more money into Facebook ads to build my list assuming that I'd get a return on that investment. I continued to invest in conferences and meeting people offline and online. If I had followed the Profit First principles, I wouldn't have doubled my revenue again, for the second year in a row.For the first three years in my online business, I put everything that I could have paid myself back into the business to make the business bigger.
In your fourth year of business, you have a solid track record and your budget is a no-brainer. You want to keep growing. You need to step it up and continue to invest big time.
I wanted a seven-figure business. After achieving $340,000 in my third year, I knew that could only happen by investing forward. So, in my fourth year of online business, I continued to do things that contradicted Profit First principles.
I started by retiring my husband. That meant we lost one salary. I joined my first high-level VIP Mastermind, I put chunks of money into Facebook ads, I bet big on launches. If I had followed the Profit First principles, I wouldn't have achieved my goal of making 1 million dollars in one year.
Profit First doesn't work for my type of business. I continue to break the principles with great success. I believe that you need to invest forward as an online entrepreneur and not treat it like a leftover, which is what Profit First does.
Why Making a Profit is Not Essential at First
Now I want to address the concept of profit, salary and taxes. Profit is whatever's left after you've paid all your business expenses and a salary to yourself. Corporate taxes are paid from your business profit and income tax is paid from your salary. If you have a sole proprietorship then corporate tax and income tax is possibly the same thing depending on your country and business setup. If you have a limited liability company then these two things are separate.
When you have a business based on your personal brand, you're probably never going to sell your business so there's no need to have a profit. Profit is needed when you have a business you plan to sell. The value of the business is based on how much profit you make each year and then a multiplier is used to put a price on the business.
For example, when I was running a software company, we had 20% profit. We could then sell the software company for seven times the profit. It was the same for the family business my parents had for over 30 years. We never had a profit in the business. But three years before we planned to sell it, we started to have a profit to make it more sellable.
In your first years of business, it's very normal to have a loss or zero profits. At some point you will of course have profits but having them from the start like Profit First suggests doesn't make any sense. In the first two years of my online business I had a loss and then a good profit in the third year and a huge profit in the fourth year.
Why I Didn't Pay Myself a Salary
Profit First suggests you take out a salary for yourself before you pay your business expenses. I couldn't disagree more.
When I started my business, I planned to build a big business, a business that would support my family – and make an impact. If you're building a big business, it does require some sacrifices. I didn't pay myself a salary for the first three years in my online business. I put everything that I could have paid myself back into the business to make the business bigger.
If I hadn't done that, I wouldn't have the multiple seven-figure business that I have today. You might wonder what I lived on if I didn't pay myself salary. I put money into the company that I could take out without taking it out as salary. In the beginning, my husband also supported me before I was able to retire him. And then the company also pays some of my costs so I don't need the same salary I did when I was employed.
Taxes is another bucket that Profit First says you should save up for. If you don't have a profit, you don't have taxes, so that's an easy one. Of course, you'll have a profit at some point but normally not in the first few years of a business. If you have a sole proprietorship, your salary's automatically whatever's left over at the end of year. From there you need to pay taxes of course.
Talk to your tax advisor about how you can optimize your taxes and possibly change your sole proprietorship to a limited liability company where you have a lot more options on how to optimize your taxes.
Profit First Doesn't Work for Online Businesses
Online businesses are largely built up on launches. That's how you really grow fast in online business. And launches happen one month and possibly there's no launch in the second month.
According to Profit First, I would then just take out a salary and owners pay and taxes after a launch and whatever's left, I can invest. I might go ahead and invest in all kinds of tools and then next month when I don't have a launch everything comes crumbling down.
Let's say I reverse it and calculate this from a month where I'm not doing a launch. I take out the small revenue that's coming in to my bank account and take out the profit, the salary, and the taxes, so there's nothing left to invest.
If there's nothing left to invest, you're not going to be able to launch the next month and if you're not able to launch in an online business, your business won't grow, so using Profit First kills your growth.
Profit First Doesn't Work for High-Growth Businesses
Will Profit First work for you? If you have a small business and are not looking to grow, then yes. If your income is predictable and stable throughout the year, yes. If you have trouble managing your cash flow, you should definitely look into Profit First.
My conclusion is that Profit First doesn't work for high-growth businesses like mine. It doesnt' support a big money mindset where you're willing to invest forward and even go without salary for a time while you're building your business. It actually encourages a small mindset. It ensures that you take away anything that could fuel the growth of your business.