Profit First Explained: New Cash Flow Insights for Entrepreneurs

I'm from Mountain Lakes. If you're not familiar with New Jersey, you know this about New Jersey. We don't have mountains and we don't have lakes. And so the proper name for my town is Hilly Puddles. New Jersey, we, you know, we have big beliefs. We want to roll big. I had a business coach who once said to me famously, at least famously to me, he said, Mike, when one person says a dumb thing, it's dumb. He goes, when 10,000 people say a dumb thing, it's still dumb. And yet it seems that societally we have certain beliefs that just perpetuate on and on, and we just repeat them because everyone else says them. They're called axioms. When I was in grade school back in the '70s— and I know you're thinking instantly, this guy's in his 50s, like he's 53, he doesn't look a day over 52. Thank you. Thank you. When I was in school, I remember in third grade I took my first test on the solar system. And I failed the test. I got a big F. And the first question was, how many planets are in our solar system? I put 8. Teacher said, there's 9. The next question said, which one of these planets does not fit? And it said Mercury, Venus, Earth, and Pluto. And I said, Pluto's not a planet. Now, Before you're like, oh, this guy is like Carl Sagan? Like he knows, he's like a cosmic, you know, planetary scientist. No, no, no. I'd finish the sentence. I said Pluto is not a planet. Pluto is a Disney character. So the correct answer, by the way, is Earth. Mercury, Venus, Pluto are all Greek or Roman gods. Earth means, it's Germanic, it means the ground. So big F. But here's the funny thing. Today they've discovered that Pluto is not a planet. There's only 8. I was right. I was— I am Carl Sagan. Well, there's another belief that exists today. I gotta find my markers here that we're gonna fix together, me and you. There's a belief that's established and perpetuates societally, and this is what it is: that your business our businesses depend on this formula: the sales you generate minus the expenses you incur results in profit. This is a foundational formula. This is the foundational formula for profitability. I'm going to turn this this way so the rest— oh, actually, you can see on the screen. We all know this formula. It's taught in tens of thousands of books. It's in our vernacular. We call profit the bottom line or the year-end or the final take. And I'm here to say this is like saying there's 9 planets in the solar system. It's a mistake. It's a lie. There was a study conducted by the SBA, Small Business Administration, in conjunction with one of the largest banks in the US, and they ran a study of the 33.2 million small businesses in the US. And just to give context, a small business is a company that does $25 million in annual revenue or less. So if your business is doing $25 million or less, you're called a small business. That's absolutely my business. I suspect it's many of us in this room. They identified that 83% of us are surviving check by check. 83% of us don't have enough money to pay the payroll, pay the rent for their facilities, cover all the expenses, let alone pay ourselves an appropriate salary. And profit? Pfft. That never happens. I just spit on the front row. I apologize. I apologize. Yeah, the fact you're wiping it on your face is amazing. That was amazing. Okay. The vast majority of us are not profitable. We're not sustainable businesses. Now, that means statistically in this room, you are struggling with profit. And continuing the equation, if it's not you who's struggling, it's the person sitting to your left. And to your right who's struggling. 83% of businesses struggle with profitability, and the question, of course, is why? And I would argue it's because we've been told a lie, that this is the biggest lie of all, because sales minus expenses does not result in profit. And why doesn't it result in profit? Because while this makes logical sense, it doesn't make behavioral sense. If you love your family, I know that's an assumption. This guy's clearly from New Jersey. Oh, you're family now, and I love you. If you love your family, do you say, I love my family so much I've decided to start putting them last? Of course not. If you love your family, you put them first. I value my health so much that starting today, I'm going to put my health last. Never. I'm going to put it first. It's human nature. When something comes last, it's the mañana syndrome. It can wait. Not today. When something comes first, it's prioritized. And we are told in this formula that profit comes last. Yeah, it can wait. So for most of us, we wait until the end of the month or the quarter, or for most of us at the end of the year and ask ourselves, is there a profit? When there's not, we're like, well, I'm going to kick the can down the road on profit and maybe it'll happen next year. And so for most of us, it's no profit, no profit, just getting by, just getting by. We're going to fix that and we're going to fix it really simply and introduce you to a brand new formula. I call it the Profit First Formula. Works like this: your sales, which is your source of revenue of course, minus your profit results in expenses. Now I know there's a couple folks in here, probably many, that are pretty smart with math principles. Do you know mathematically this is the exact same equation We did what's called a variable swap. We took expenses, put below the line, move profit above. Logically, these are the exact same thing, but behaviorally it's radically different. What I'm saying is every time revenue comes into your firm starting today, you're going to take a predetermined percentage as profit, allocate it, hide it away from your business, and live off the remainder. That's the expenses. This is the pay yourself first principle we all know about in our personal finances. Apply to our business? That's what we're going to learn together this morning. Now, I do have a worksheet that's handed out on the tables. If you can't recognize it, it's the one with the picture of that handsome fella in the top left. I did make that wallet size for you if you want. Okay. Oh, he's from New Jersey and egotistical. Okay. We answered number 1 already. Society is addicted to axioms. An axiom is an established belief that we perpetuate because other generations said it was true. The solar system has 9 planets. That's what everyone says, has 9 planets. We're told profit comes last. Okay, profit comes last. So the first answer is society is addicted to axioms. If the prior generation says it's true, the current generation, us, assumes it to be true. So axioms, generation, generation. We also answer the rest of that. As a result, today, according to the SBA, 83% of small businesses are surviving check to check. So I'll help you fill this out as we move along if you don't catch them. But 83% of businesses survive check by check. We have been told that profit is an event, an eventuality. It'll happen sometime. I'm here to say profit is not an event. Profit is a habit. That's the answer to number 2. Profit is not an event, it's a habit. We're gonna bake it into every transaction of your business. And we're gonna do it following some principles, interestingly, from physical fitness. I too am an entrepreneur. I currently own quite a few businesses and have been an entrepreneur ever since I graduated from college. Because, because I couldn't find a job, to be honest. And my businesses struggled because I lived by this. The only way I saw as making a profit, taking home money, was if I simply sold more. So my early businesses, which were in the tech space, I kept on saying, I'm not profitable. Maybe when I achieve the first half million, or maybe when I achieve when I get to $3 million. Ironically, it's when I got to $3 million after 7 years of effort, not being profitable, constantly being break-even, that I achieved my first profit. I got a call from my accountant. His name is Keith. He said, Mike, congratulations on all the growth and effort. I have wonderful news for you. You have a profit. And I'm like, are you serious? This is amazing, Keith. I'm like, how much is it? He goes, you have $15,000 of profit. I raced down to his office. He pulled out the P&L, you know, the profit and loss statement. You know, on the bottom says $15,000. He circled it with a big red marker. And I'm like, this is amazing, Keith. This has been my dream. Thank you for sharing this. And then I asked him a question I forever regret. I said, I said, Keith, where is the profit? Thank you. Clearly, we are awake and participating. Yeah, thanks for laughing at me. That's a joy. So here's the— have you noticed between me and you, have you ever noticed how an accountant laughs? It's laughing that reverts to maniacal snorting and mocking and mocking. Keith, when I asked, I said, where is the money, the $15,000? He goes. He goes, you don't have any of that. He goes, you've blown it all. It's gone. He goes, that's an accounting profit. Who says that? My accountant says that. This is an accounting profit. What we're going to talk about what I commit within account. I got 50 minutes to do this. Within the next 50 minutes, we're gonna make your business permanently profitable as we define profit. Cold hard cash waiting for you at the end of the day to do what you want with. And if you're already profitable, kudos to you, we're gonna make you more profitable. That's my commitment. And we got 50 minutes, we have to move quick. I will tell you this, Keith, you know, as a beautiful gracious gift, Years later, after growing my business more and more, I actually became entrapped. I grew to $5 and $7 million, and actually I was taking on more and more debt. There was a point, and I'm embarrassed to admit this, but it's the reality, I became insolvent. I lost all my money. And I called Keith and I said, Keith, I'm in real trouble here. And his response, you know, the professional accountant, no duh, he says. Yeah. And I'm like, Thanks, Keith. And he goes, yeah, it's our professional recommendation that you declare bankruptcy, which was a dagger to my heart. I'd grown these businesses to become these behemoths that were cash-eating monsters, but not profitable, not money-making machines. And so I said, Keith, I know I have a tax bill coming. So yeah, you got it. You have a big tax bill. He's like, you can't pay it. So I said, what do you do in this circumstance? He said, oh, I said, "How?" He goes, "It's real simple." He goes, "Just skip paying taxes this year." I said, "You can do that?" He goes, "No." Here's the funniest thing. He's still my accountant. That moment, and I won't belabor the story, but that moment became transformative for me. I set myself on a mission to determine how to be profitable at any size. I am energized about the topic of profit, if you haven't guessed it already, because I want you to be wildly profitable. In fact, your customers are starving for you to be profitable. Listen, you'll never have one of your customers come up to you and say, hey, can you charge me a little more? Could you rip me off a little bit? Could you screw me a little bit? That's the screw gesture. If you didn't know, sorry. Yeah, your customers will never say that, but they will say, I want your undivided attention. I want to be your number one customer. I want to be taken care of. I want to be treated as your only customer. And you know, the only way to take care of our clients to that degree is if you're sustainably profitable. If you're not, it's constant panic. It's constant fear. I gotta sell more, I gotta do more. We can't pay attention to our clients. Your clients want you to be wildly profitable. They just won't use those words or hopefully those gestures. So how do we become profitable? Well, it's a lesson from physical fitness. I was watching television one day and the fitness instructor came on, shared 4 principles that were kind of out of the box to me around physical fitness. The first thing was about our diets. I don't know if you know this, but societally we are becoming a bigger person. And the reason the fitness instructor said was because the size of the plates we use at our homes. I don't know if you know this, 300 years ago a plate was this size. George Washington was eating off what we call a coffee saucer. Truly, that was their dining plate. Plates have doubled in size. We serve just like we have in the past, fill up the plates. Our mom tells us clean up the plates, and because we have double the container, we have double the servings, double the consumption. The fitness instructor said the most simple way to control your caloric intake is to have smaller plates at home. Does anyone here by chance have teenage boys? Just raise your hand if you do. Okay, I'm deeply sorry. I'm deeply sorry because they're not called teenage boys, they're called creatures. Right? The food consumption is redonkulous. I have two of these goons at home. Tell me if you can relate to this. My boys wake up somewhere around the ass crack of 2 in the afternoon. Right? Oh, you feel me already. They come out of their lair bedroom. You know they're coming. They're for such awkward humans. They're awfully silent, but the stink emanating in front of them. And so my two monsters come out and there's just a smell like, oh, someone asked me once, is there something worse than the smell of a rotting corpse? And the answer is teenage boys. And they come up and they would come to our kitchen and they come to the table and we'd have our Cheerios box out. Now at our house, a box of Cheerios with teenage boys lasts about every hour. You're going through a box, you know, and they come and they fill it up and there's this heaping mass and they add milk and there's this explosion and stickiness and then they grab their bowls, they can't speak English, they just go and they go back to the lair. And you're kind of grateful that they're back in the stink central. I tried an experiment based upon what this fitness instructor shared. What I did was all of a sudden down here got super clumsy around the house. I broke all the bowls in our house. I know, yeah, thanks for participating. I then, I then Got slightly smaller bowls. I went to the local whatever store and got one. I didn't get these little ramekin dessert bowls, just so we know. I got slightly smaller ones, and the goons never noticed. They would come up, ask, crack a tooth, they would fill up the thing and go away. A month later, I broke all the bowls again, got slightly smaller ones. This took me 4 or 5 iterations over 6 months, but I got the bowls to half the size, and they never noticed. But here's what happened: that box of Cheerios started lasting us like 3 days, which with teenage boys, like, is the definition of a miracle, right? The lesson one when it comes to our finances is the container is dictating our consumption. If we simply control the container, we are set for success. Let me ask you a question. I asked for full participation. So you got to raise your hand for this or not. It's a good way for us to survey each other. How many business owners in here have what's called a primary checking account? What I mean by this is you deposit most of your deposits in there and you pay most your bills from that. If you have that, raise your hand nice and high. Excellent, excellent. Okay, I would say it's hard to survey, but I'd say 80% of the room. I actually thought it'd be more. One more question just to measure participation. By a show of hands in this room, who has hands? Not everybody, apparently. Are you kidding me? Oh, I work for Cinerama, I'm handless. Okay, good to meet you. Here's the deal, I would say, since some people are choosing not to participate, I would say 90% of this room has a primary checking account. If you If you raise your hand or if you have a primary checking account, you are primed to be very profitable. And that's my commitment now in the next 45 minutes. My second question is, who here, even though your accountant may say never do this— my accountant says look at the income statement, the balance sheet, the cash flow statement, the KPIs— who here follows a simpler system like I do and at least once a month at least once a month, logs into her bank account to see how much money you have. And if you see money, you know you can spend it, and if you don't, you panic. Who checks their bank account at least once a month? Raise your hand. Once-a-monthers? Okay, good, about 90%. Any once-a-weekers? Once-a-dayers? Your hand— you're checking right now, aren't you? As Bill Clinton famously said, "I feel your pain." I feel it. I'm with you. I do the same thing. I check my bank balance coming up in here. Oh my God. Most humans manage their finances by logging into the bank account. Therefore, if you do that, you will be wildly profitable. Because here's the core lesson: changing who we are is very difficult, but channeling who we are is very simple. Don't change who you are, channel who you are. So the fact you log into your bank account, we're gonna make that your biggest asset. Here's what we're gonna do. The first thing I want you to do is whatever bank you work with, we're going to set up multiple small bowls or plates. See, right now you have one big Cheerios bowl and your stinky, smelly teenage business walks into the bank account and just says, I'm going to gobble it all up. So what we're going to do is we're going to set up 5 I call them the 5 foundational accounts. This is on your worksheet too. First account, it's called income. I'll explain each one in a second. Second account, it's called profit. Third, it's called owner comp. Fourth, it's called tax. The fifth and final, it's called OpEx, stands for operating expenses. This is, let's see on your worksheet, this is number 3. So what are these accounts? Let me get a different color pen. The first account there, the income account, is going to become what's called a depository-only account at your bank. Here's what I'm suggesting: every time a deposit comes into your business, we're going to deposit into the income account and let it sit there. The reason we're going to do this is your business has many teenagers that need to be fed, many components that need to be fed. So we're going to allow money to come into the income account and carve carve it up. It's kind of like Thanksgiving. Last Thanksgiving, my wife and I hosted at our house. We had about 20 guests over. And so the turkey comes out of the oven, half the family has to post this on Instagram. Like, oh my God, a golden turkey. No one's ever seen this. Fine. My family's, you know, listen, they're like me. It's a disaster. So here's what I didn't do. I didn't say, hey, everyone Just grab a knife and fork. Whoever wants the most gets it. Fight for it. No, I carve the turkey. And if you celebrate Thanksgiving, I suspect you carve up the turkey. And why do you do this? So every guest at the table can get a piece. Income is our cash turkey. Money flows in and sits there. Then on a recurring or periodic basis, we're going to allocate portions of the money to different accounts. The first account we allocate toward is profit. Let me give context what profit is. Profit is a reward for starting and running a business. Another study that came out from the SBA, 17% of the population will ever start a business from scratch, as a franchise, as a freelancer. 17%. If you look back at kindergarten, I had 30 kids in my class. 17% is 5 kids. There's 5 kids from your class who started a business. There's another statistic that the SBA revealed, that only 20% of those business owners sustainably keep the business in a healthy state and can employ people. 20%. 20% of the 17%. Well, 20% times 17% is 3%. 3% of your kindergarten class is running a healthy business. That's you. You're the weirdo. You're the weirdo from your kindergarten class. You're the one kid that did it. And gosh, if you knew you were getting into, you would have never done it. But you did. You did. The other kids from the kindergarten class are looking for good jobs with good companies doing good things. That's what you're doing. The number— and this is not in your notes, but this is one thing to remember— the number one job of an entrepreneur, of a business owner, is not to do the job. It's to be a creator of jobs. Maybe you want to write that one down. The number one job of an entrepreneur is not to do the job, it's to create jobs. That's your job. Well, you know what you get as a reward for running a business? You get profit. Profit is a thank you for taking on massive risk, for doing what only 3% of the population pulls off. Thank you for providing for our economy. It's massive. I got a check. I own some public stock. I own some shares in Ford. I don't know why I'm like rolling my eyes here, but I do. I own 100 shares. This is not a stock tip apparently. I own 100 shares and last quarter I got a check for $13.23 from Ford. I opened— thanks for laughing at me again. I opened up my distribution check and I looked at it and I didn't say, ah shucks, I don't deserve this. Ford, I'm going to plow it back and reinvest it in Ford. Actually, if all the shareholders would just return all the money, we could go and grow. Now, I said I took risk. This is a payment to me for taking risk. And I didn't say I had to head down to the factory and see how many hours I got to work to earn this. I took risk. Profit is not to be plowed back or reinvest in your business. Profit is not used as your salary. Profit is a thank you for investing as a shareholder in your own business, which is different than owner's comp. Owner's comp is the pay for the work you do within your business. I had a chance to meet a few folks early this morning. They were hungover. Between me and you, one guy was still at the bar. You know who you are. Oh, that was me. That was me. Owner's comp. Owner's comp is compensation for the work you do. And I talked with some owners here, and it's unbelievable what I heard you do. You're the best technical expert in your business. You're the best sales representative. You're the best at customer service. You sacrifice time with your family. You, you miss holidays and vacations. You do anything to keep the business going. If I could get you to do all those things for for me at my business, you'd be the golden child. Like, you'd be the ultimate employee. And if I— if you allowed me to pay you what you pay yourself when you came to me, which is zero— think about it. You have an opportunity to move to New Jersey and work for me. Your business has landed the number one employee in the world. The number one employee in the world, it's you. No one will have the drive or dedication or devotion for you. And imagine having to replace yourself. What would you have to pay that person to replace you? $100,000? $500,000? Millions? I bet you it's a big number. And here's the deal. If you're not paying yourself that, your business is not treating the number one employee properly. You have to pay yourself that salary if you ever want to sell your franchise, You better have the proper valuation. You better be demonstrating that the business can afford what a key employee does deserve. If you don't want to resent your business like I have resented so many of my businesses because I'm paying employees checks but not paying myself, you must pay yourself. I suspect if we did an interview in this room, how many people started their business for financial freedom? I bet you even the handless people would throw up a nub. Everyone here. If someone here does not have a hand, like, listen, I get you. Let's— we can talk. I'm sorry. I'm sorry. I hope you see the humor now. But taxes, taxes. We started our business in part for financial freedom, hopefully personal freedom, do what you want when you want. But financial freedom is to never worry about a bill. But the biggest bill we worry about rolls around April 15th. I owe How much to who? My God. And then your giggle-snort accountant's like, "It's tax time." Your business can pay your taxes. Now I realize you may have a different formation for business, LLC, hybrid, you know, S-Corp, C-Corp, it doesn't matter. Your business can always reserve tax liability. Talk with an accountant. They may have to reimburse it to you as the owner, or it may pay it directly to the government, but your business can pay taxes. In this last account here, OpEx is the operating expenses of a business. It's what your business runs on. Now, we won't spend time on it because we're tight on time, but if you look at the back of your worksheet, there's a thing called the TAPs chart. Stands for Target Allocation Percentages. My company studied 1,000 different businesses, industry agnostic, and identified what the top fiscally elite businesses do. So just for pretend sake, I'm going to say your business is doing $2 million in revenue. You can find the column you're in. Ignore real revenue, that's an advanced topic. Let's just go on to profit. You'd be in column D if you did $2 million in revenue, and the allocation percentage would be 10%. The carved-up turkey would get 10% there. The owner's pay would be 10%. The, um, uh, tax would be 15%. And then the remainder, the difference would be 65%. So if I add these up, 6, 7, 8, 9, yeah, it's 100%. So just to play this out with financially, if I make $2 million of revenue at the end of every year running these percentages, you should have a $200,000 bonus check waiting for you. You should be taking home a compensation on top of that of $200,000 as your salary.