Profit First: Practical Steps for Small Business Financial Success

Mike Michalowicz explains Profit First, a system that splits revenue into separate bank accounts to force profit discipline. Start with a tiny profit percentage (1% of revenue) and raise it each quarter toward your target. New startups can jump straight to target percentages, but established businesses need to move slower to avoid cash flow problems.
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Entrepreneurship is hard, but the process can be simplified. You can achieve success faster, sooner, and easier. I'm Mike Michalowicz and I'm on a mission to eradicate entrepreneurial poverty. My goal for this episode and every episode is to serve you on your journey. Let's start right now on Entrepreneurship Simplified.
So this is now officially episode one.
We're on episode five.
We're trying to nail the. The technology here, and we're just doing a simpler setup and maybe this will work.
Maybe this will do the trick.
The challenge we have is we got to get the files off these phones uploaded.
Yeah, we'll figure that out. Okay.
Okay.
I have faith in you, Mike. You know, we have faith in Kelsey too.
Yeah, someone does. All right.
All right, Mike, Today I want to talk about last week. We talked about profit first, what it is.
Yes.
Today let's talk about implementing it. I want to know, you know, the practical implementation and answer some of our readers most frequent questions about it.
Yeah.
Because there are a lot. And let me start with determining our caps and taps. Okay, first define, please, and then tell us how you define them.
So I'll give the quick kind of 30 second overview what prop first is, and then we'll go into caps and tap. Okay, so Prof. First is a cash management system for business. It's not an accounting system, so we got to be clear on that. It's a system that runs at your bank. The reason it runs at your bank is called a behavioral intercept. If you log into your bank account to see how much money you have so you can determine what you can spend. That's normal human behavior, but we need a system there that tells us what the money is available for. So we have multiple accounts set up, like envelopes at your bank. Minimally, we set five. An advanced deployment. Profit first could have tons, but the. The danger is we hear, oh my God, like 10 accounts. It feels like such overwhelmed people avoid it. So the essence of prop first is you start slow and let it grow. So if you want to implement prop first, the first thing I tell people before even the caps and taps, I say just set up one additional account. Your bank, call it profit. So it's a savings account or whatever and allocate 1% of your income into it. So if you make $1,000, 1% is 10 bucks. Put in your profit account, run your business off the 990 leftover, and you'll find a way, because you can run up a thousand bucks. You can run up 990, but you'll start seeing Profit accumulating. So the first step to implementing it is to start very slowly and just test the waters. Now to your question, and that was probably more than 30 seconds. Here's the caps and tax caps stands for current allocation percentage. It is the actual percentage you're allocating to each account, the current allocation. So If I'm allocating 1% to profit, that's my cap. I have a 1% profit cap. If I'm allocating 7% to owners comps, and we talked about last week, I have a 7% cap. A tap is a target allocation. Percentage is what we're targeting ultimately. Now, in the book Profit First, I did an analysis of a thousand businesses that were financially elite. These are all different types of businesses, but the best performers. So based on different revenue ranges, I have suggestions on what your taps could be. Again, I would work with a profit first professional to appropriately set those taps, or you can set them yourself. But this is what we're moving toward, the general rule of thumb, and there's exceptions, but the general rule of thumb is we start slow, 1% profit, for example, and we move toward the taps in increments every quarter. When I make my adjustments, 90 days. Okay, so say I want to set a 10% tab. I may say this today. Start with 1% at profit. Next quarter, I'm at 2% cap, 3% cap, and in over nine additional quarters, I'll get to that 10% tap.
Okay, cool. Well, how do you move your percentages from caps to tips? Just that. Just that slowly, but great question.
Yeah. So it's an incremental rollout. You don't necessarily do it in a linear fashion. So I don't necessarily start off saying, I want my profit 1%, and next quarter, 2%, ultimately getting to 10%. You may say, I want to move more aggressively in the beginning. And this is where it's good to get external guidance, PfP. But you may say, I want to go from one to five to six. And then we're do a six and a half, seven, seven and a half, and slowly move it up.
Okay.
There's two mistakes people make when it comes from going from your cap to what you're targeting, your tap. Some people go too aggressively. They say, you know, I want to start, achieve 10, let me start at 10. And it's so abrupt. It's like trying to start a car in fifth gear. It just, if you remember, manual systems, yes. Stall out. Other people start too slowly. They say, you know what, let me do 1%. See how I do and then let me go at one and a quarter percent next year and let me stay there for a while. And they never push the business forward. It's interesting. Like exercising, if you don't push yourself, you don't build the muscle. So if you keep a cap very low for profit, for example, you'll never improve that enough if you're not feeling the consequence of it. So when I start taking 6 or 7 or 10% or maybe 20%, depends. For your business for profit. Now I have to balance that by compressing my operating expenses. Now it's going to put pressure on costs, pressure on margins, increasing them. It's going to put pressure on efficiency, improving it. So you need to do enough where you feel the pressure. Knopbacks. But if you go too far, it's like putting too much weight on. You could injure yourself. Ah, that's why I like to get a trainer.
I gotcha. So it sounds like you're saying you can do this even if you're just starting out.
Yeah. Can you do this if you're just starting out? The answer is hell yes. And here's the irony. If you're just starting out, you can be far more aggressive because you don't know any alternative.
Right.
It's like a baby being born and introducing a language like Spanish. You just learn it. That's your language.
Right.
I have cousins in Germany, Sarah and Jan. Guess who's the original?
Yeah, I'm going with you.
Yeah. And they have two children, Minou and Milad, and they speak four languages. They're. The oldest is eight years old. So think about that. Spanish, Farsi, German and English.
Incredible.
Fluently and accentless. It's like, my God. Now try as an adult, like I'm trying to learn Spanish. Duolingo.
Yeah. Instead, like that's pretty much as far as we've gotten.
All right. Screwed. What's interesting is a brand new business starting with profit first doesn't know an alternative and therefore adjusts far better. So if you're in day one of your business, I actually suggest start at the tabs and you'll design your business from day one healthily, the right way. You don't have to relearn or unlearn.
Right.
Just do.
You just do.
It's a more established business that we have to go through the dual lingo process and be a little more gentle with. It's. It's the ultimate irony. Small business, brand new startups have the advantage. Yeah, Go all in.
Now what if you're an established business but You've got debt. Can you do it?
Yeah, if you have debt, here's the irony. You have to do profit first. Well, you have to be profitable. And I would suggest profit first. So here's the argument I hear from people. I have debt. I have $100,000 of debt, which is to me, an overwhelming amount of debt. And I've been there, I've been worse. The business owner say, I gotta pay off my debt before I can be profitable. Do you know the only way to pay off debt is by being profitable? And what I mean is this is debt is a expense you incurred in the past that you couldn't afford, or at least chose not to afford, so you bought, you used other people's money to pay. Now you're indebted to them. That's what that is. So debt means use other people's money. In the past, the only way now to pay back that creditor is to make more money than you're spending, AKA profit. You have to be profitable to have that excess to pay debt. So start the profit first system immediately, allocate money to a profit. There's one exception. When this profit distribution comes out, you're not going to use it to reward yourself. You're going to use it to pay off the debt.
And that feeling is kind of a reward in.
And that's worse because now you're chopping down debt, but a small portion of that profit still goes to you. There's operant condition I mentioned last week. There's reasons why we want to still reward ourselves, at least in small portions. So a small portion comes to us to, to empower us to keep doing profit. But also by running the profit first system repeatedly over and over again. And yes, we're using that profit to pay off debt. Once that debt's eradicated, you now have mastered the profit for a system. And when that next distribution comes out, you're the recipient of all of it.
Okay, so I'm a new business owner. What is my first step if I'm implementing profit first? I mean, what is my very first move?
Yeah, first of all, I didn't know you were a small business owner. Congratulations.
I'm not. Oh, you tripped.
If you're a small business owner, the very first move is get your butt to the bank, like immediately. Ironically, it's the hardest step and requires, you know, 15 minutes of effort. Maybe you gotta drive there in person. Probably can do it online. Almost all banks now are online. Literally 15 minutes or less. They say, when's the best time to Plant a tree and you know the answer is 40 years ago. When's the second best time today with profit first. If you didn't implement profit first 40 years ago, you gotta get started today. It is designed to work with your bank, so you've got to get to your bank instead of these accounts. Now I'll give you the ultimate hack. And this is low proe, but the best bank for this hands down is Relay. We use them as our bank.
Yep.
They designed their banking system. They're a app that sits on top of bank, so it's called a banking platform. They designed their banking platform from day one to support Profit First. There are tens of thousands, I think even beyond that now, of users of Prop first using Relay because it automates this process. It makes it so much more efficient, so easy to do. We have, we're approaching 900,000 companies that are doing Profit First.
That's fantastic.
I wish they were all working with Relay. Yeah. Now here's my pluggy part. We have a link we set up called bank like mike.com. the promo does change, but right now I think they're funding your account $50. So here's the ironic, ironic thing. If you go to banklike mike.com and set up a bank account with relay, you get $50 profit instantly right to.
Your account right there.
It used to be, remember in the olden days, you'd go and you get like a, a sandwich and that's it. You get like a toaster.
Yeah.
You go to the bank, you sign an account. Yeah, I prefer that. You get cash.
I'd like the cash too. Yeah, I'll take it. And then there's another resource for people and you tell me you're. If you're a new business person, do you call Profit First Professionals or are you waiting till you're established before you call Profit First Professionals?
Yeah. So Proffers Professional is an expert that's been certified Profit first methodology. They've been trained by me and our company and they have a proven track record of recertifying, improving their capabilities. They have experience and I have the support of the organization myself behind them. So the sooner you get started with a professional, the better. I equate this to a trainer at a gym. Talking about it earlier. You can, anyone can join a gym. The recipe is the book. The book exists. So you have the instructions set, how to work out. The question is, are you still going to go to the gym? Some people go to the gym and have the, the discipline and the ability to, to do it right Your husband is that type of guy.
Yeah.
He doesn't need a trainer. He'll go. But he may have chosen at times to have a trainer because they tell you the right exercise to injure yourself. But other people also need that accountability. I'm a little more in that camp.
I'm totally in that camp.
Yeah, my wife too. So my wife has a train. She goes and does Pilates. She is a Pilates trainer.
Yeah.
She knows the exercises, but she has someone that enforces them.
Yeah. Hold her accountable.
Holds them accountable. And she says, oh, modify this because you're going to injure yourself if you do that. A profferance professional. Make sure that you do it. You're accountable. Make sure you don't injure yourself. Overdo it or underdo it. They keep you moving along. So it's accountability and proper execution. So I really encourage people to reach out to a PFP to consider them. They aren't absolutely required, but definitely, they definitely help.
Yeah. Not just. I'm all right, Mike, thank you.
Yeah.
So on to some other stuff.
There's a news.
Onto some news.
Oh, what's going on in the news?
Well, well, the Olympics were going on in the news. They're. They're just wrapped up. I watched a lot of it and my gosh, the gymnastics. The floor routines for gymnastics get me every time. Goosebumps all over.
My favorite part of the Olympics. I watched. I watched the most Olympics this year that I ever had.
Yeah.
Really enjoyed it is the camaraderie at the end when they have the closest. There are the Australians, the Americans and the Africans and China hugging each other.
Hugging each other. Yeah.
The accomplishment of these people.
Yeah. Everybody knows the sacrifice the other person is made to get there. Yes.
And the respect they have for each other is like, wow, it's so good to see these representatives.
Yes, yes, I agree. I agree so much.
We are government officials and we don't.
Get along because the. The article I had seen, or something somebody had pointed out was the incredible cost of what it cost. So Rio in 2016 cost $24 billion. 24 billion equivalent to approximately $1800 for every person living there. They cut basic services to the population like health care, education and police to make up for the cost. London in 2012, 17 billion. Tokyo in 2020, 14 billion. And they're having a hard time finding cities who are willing to do it because nobody's ever stayed on budget.
Yeah.
So, like, it's such a. It's a hard thing to. To justify doing. And yet you see Those, you see those moments where those athletes are, are doing those things and you're like, it's incredible. It's such incredible.
Yeah. So it'd be nice of these countries and these cities did profit first.
Yeah, right, right.
Where we worked with a corporation and I can't disclose their name because it's a publicly traded company that reached out to us and said we want to do profit first but we can't announce it because you're not allowed to due to Sarbanes Oxley and these different legal compliance. Well, you can't take your profit first. But they said theoretically it's the best thing we did. So what we did is we said, how's your organization working? They said, we have product leads. So say it's a large corporation and I'm a product lead for a $10 million line of products. I make pictures like I have st here behind me.
Right.
They would say, oh, we just got an order for pictures. Here's as it's an order for 800,000. The order was actually a million dollars. They took the profit at first.
Ah.
What was so interesting is the product leads were making on average a 5% profit. So if I was a product lead, I got a million dollar order, I would have a fifty thousand dollar profit. When they took the two hundred thousand off first and didn't tell it properly, they still made a 5% profit. So it's human nature.
Right.
The problem that the Olympics is experiencing, I can only expect is natural human propensity to expand our demand based upon available resources. And so we max out what's we're told's available.
Right.
And then we're told, okay, there's more and like great. And we keep expanding.
Yeah.
So if we put intentional constraints around us, we become innovative, we find our solutions. I wouldn't be surprised if there's massive inefficiencies and redoing and unnecessary things done for the Olympics. That's just wasted.
Yeah.
But if we constrain ourselves, I bet you we'd be within budget or betting.
You got to be the next guy to run them. That's it.
Yeah, yeah, I'm. Well listen, I'm all talk. I go there, I'm like, let's spend.
This is going to populate bigger, better.
Olympics would be destroyed because six more stadiums. So easy said.
Yeah.
Hard to do. Especially when there's committees and groups. That's the advantage small business has. Small business inevitably is one or two people that are operating the business. We can move such more agile.
Lee.
We are so much more flexible and we can work within the constraints that are forced upon us. And that's why first is so successful for small business when it comes to these bigger implementations. We have to figure out those tricks. Like not telling someone about a number.
Yeah.
And that's how we do it.
Awesome. Mike, thank you so much for this. Thank you for simplifying entrepreneurship for us.
My, my joy. And I want to thank our guests for listening in to entrepreneurship simplified. That's the mission of the show. Hope you got some ideas you can take away from this. We enjoyed the podcast. Do ask that you subscribe. That serves us. I think it'll serve you because you don't miss a single episode. And we'll see you next week. You don't know the topic we have next week. Two weeks. Yeah, we started working on it, so I just put you on the spot. I know it's going to be amazing. So make sure you're here next week. See you later.
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