"Profit first" is better for entrepreneurs than "G.A.A.P." | Mike Michalowicz | TEDxFultonStreet
Mike Michalowicz went from building multimillion-dollar companies to broke using traditional accounting, then discovered that treating profit as leftover money was the problem. He proposes Profit First: take profit out before expenses, which forces you to spend less and innovate harder. The method turned his business around and made his most profitable year ever.
There is a formula. There's a formula for profit. There's a formula for wealth. It's actually the exact same formula and it works perfectly until the moment it doesn't work. I followed the formula and actually grew a couple multimillion dollar companies that way. And found as I grew these companies that my profits and subsequently the income I made for myself, my own wealth occurred as an event. Grow, grow, grow. And I sold the company. And that's where I made my wealth and do it again. And for selling my second company, for the first time in life, I was a millionaire. And let me qualify what I define as a millionaire. I just breached a million dollars in cash and net assets. And then when taxes came, I stepped back below. So I consider myself a one day millionaire. That's what we look like. But I knew the formula now grow, grow, grow, and the profits will come. So I decided to become an angel investor today. I now call myself the angel of Death because I started 10 companies and every single one failed so, so badly that in two years of making my millionaire for a day status, I lost every penny. And my most devastating and humbling day in my life came next. I came home. April. I'm sorry. February 14th, Valentine's Day 2008, to my family to say the last penny was gone. I had wasted it all on frivolous, arrogant items to lots and lots of dumb investments. I sat down in front of my family in front of Thanksgiving, in front of my family on Valentine's Day. And we celebrate it kind of like Thanksgiving. We all sit around the table and enjoy a wonderful meal together. But I was sad, stoic. And my wife looked at me and said, what's wrong? And that's all it took for the dam to break. I started to sob and cry to the point where I'd say, it's kind of like you could hear a pin drop. But my sobbing was so intense you couldn't hear a pin drop. It was like that. Thank you for laughing at that. Appreciate it. I'm happy we're that close already. You can laugh at my embarrassment. And my family stared at me and had nothing to say. And my daughter, 8 years old at the time, ran out of the room. And when she ran out of the room, I wanted to run out so badly too. And then she came back with her piggy bank. She put it down on our dining room table and slid it to me and said, I'm going to help us. That's a humbling moment. And what I realized in that moment was the formula I believed for financial success is a broken formula. It's called gap Generally Accepted Accounting Principles. It's an axiom. An axiom is. It's a truth that we hold in our minds because everyone else is doing it. There was a time with the world when we thought the Earth was the center of the universe. We all believed it because everyone else did until we realized it was wrong. The world was flat until it was wrong. Man couldn't fly. Until he could, we would never leave the planet until we did. And gap's another one of these. And the funny thing about Generally Accepted Accounting Principles, it's. It says, it's an axiom right there. Generally accepted. We just generally accept it. The formula looks like this. Sales minus expenses equals profit. Perhaps you use this formula yourself. This is how I grew my business sale. As much as you can incur expenses to support those sales and then you have profit. Profit is a leftover. It's an afterthought. And for myself, how I'd run my business, and perhaps you do too, and perhaps even your life is. I look at my bank account every single day and see how much sales has accumulated. And then I would see what bills had piled up that I could pay, extract from my sales and pay the expenses. That's what the formula says. And then I'd look for the leftover profit. Fortunately, there's rarely a leftover there. Never. In fact, only when I had this big moment of selling a business or a huge customer would come in and there'd be some profit more momentarily until my expenses would expand to fill it. There's a principle called Parkinson's Law. Nothing to do with Parkinson's disease. But what Parkinson's Law states is that when a resource is made available, we consume it all. If we have four hours to get a project done, miraculously, you will do it in four hours. But when you're given four days or four weeks, it will take four days or four weeks. That's the power of Parkinson's law. And while this formula is very logical, it doesn't account for Parkinson's law. Now, if you ever go through an experience like I did, and I pray you don't, you do. I did face with what I call functional depression. I could continue to work, but it was very hard to work. I removed myself from my social situation and hanging out with friends and just watched a lot of TV and to tried drank a lot of beer. And as I was sitting there watching my last infomercial of all things, watching Suzanne Sommer with her thigh masters and of course, I had one. So I'm watching TV like this, going, what am I doing? I decided to turn the channel, and a fitness expert came on and said, those quick fixes, the P90X's, the Thigh Masters, the ab inductor that electrocutes you every five seconds, those things don't work. Not that they actually don't work, but they require us to change our behavior. And for us to change our behavior is very hard. He said, but there is a solution, and it's simple. Work with our behaviors. And he said, what we need to do for our health is get smaller plates. The average plate size in America today has more than doubled from what it was in the 1700s. George Washington was ripped. Not because he worked out so much with his wooden teeth. I don't know why I threw that in. It's just kind of funny. The reason is they had smaller plates, and over time, plates have increased. And our behavior is to see what's on the plate and consume it all. And that's what this formula teaches us, too. See what's in our account and consume it all. See what's in our account and consume it all until there's nothing left. I want to propose today a new formula. I call it the profit first formula. If you look at this logically, it's the same. Mathematically, it's the same, but for human behavior, it's radically different. What if today, every time you made a sale and that check came into your bank account, you first took your profit and reserved that away? What would happen now is your expenses would become a smaller plate, less available, and we could continue our behavior of consuming it all. And what it will force us to do is become innovative. We'll go back to our entrepreneurial, innovative routes and find how to get things done with the smaller expenses. If we take our profit first. This is the small plate principle played out with our financials. I employed it for my own business five years ago, and it's turned things around. Today. I'm a business author. You can't make money. As a business authority, I'm happy to say last year was my most profitable year in my entire life, regardless of all my businesses, because I used smaller plates. If logic works, every person in this room would be rich. It's simple. Spend less than you make, but we don't do it. And I'm here to say that's okay. And I'm also here to say that we have to exploit our behavior. We have to leverage how we naturally behave. Starting today, put your profit first. Always. Thank you. Thank you.
