13 Jul A New Formula For Businesses To Follow In Pursuit Of Profit
It pains me to state that in today’s small-business community, 87% of small businesses in the U.S. fail after one year, according to Bureau of Labor Statistics data (via Investopedia). Such a shockingly high percentage of small businesses have not been able to run a sustainably profitable business. This is quite sad: It means that many business owners are likely living on leftovers and are unable to secure themselves a minimum standard of living.
It’s often not their fault. They had the tenacity to start a business in this entrepreneurial world. But many of them likely listened to the age-old formula for success that has been passed down from accountant to accountant for generations.
Sales Minus Expenses Equals Profit
In 2014, Mike Michalowicz came along and published the book Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine. In the book, Mike clearly explains that it’s not a business owner’s fault if they are not making a profit. He asserts that we need to flip the generally accepted accounting principle for profit around.
Sales Minus Profit Equals Expenses
I’ve been a Profit First Professional for almost six years. (Profit First Professionals are dues-paying members of the Profit First organization who have passed a certification process in Profit First. I work with clients directly to implement and manage Profit First.) I am privileged to have helped countless small businesses transform their financials.
The key piece of this formula is that you set yourself up with a minimum level of personal income to cover your basic needs. Then, you can adjust your expectations to match the remainder of the money you have available. It is a grandma’s-envelope-type behavior system. If there is not enough money in the grocery envelope to buy grass-fed Kobe beef steak, then grandma will buy beans and rice instead. Her family members will still have full tummies.
We can apply this same lesson to our small businesses. If, after paying yourself a reasonable salary, you don’t have enough money to make the payment on your Tesla Model S, perhaps you could drive a Ford Focus instead. Humans are creatures of habit. By changing the order of our payments around and paying ourselves first instead of last, we are leveraging our habits as a strategy to spend less.
The Obsession With Tax Savings
Have you ever heard small-business owners talking about how to save money on taxes or looking for extra “write-offs” before they file taxes? I hear about it all the time. People repeat it like a battle cry to infinity: Our clients want to pay less in taxes. But the truth of the matter is that I ask my clients to pay more in taxes, not less.
Avoiding taxes is not the battle cry that I hope for my clients. I don’t want them to overpay on their taxes, of course. But if you load up on expenses and forgo profit, you are literally robbing your own piggy bank. There is a relentless obsession in the small-business community with saving money on taxes. In order to pay less in taxes, many people believe they need to spend more on write-offs that are unnecessary to business efficiencies. But what if, instead of spending more in your business to avoid taxation, you set yourself up with a powerful team of professionals (a great bookkeeper, a tax preparer, a good techie who can help you streamline, and a great financial planner, to name a few key players) who can help you build strategies to both help you establish great efficiencies and maximize your profitability? (Full disclosure: My company offers some of these services, as do others.)
Changing The Business Owner Battle Cry
Can we, as a community of small-business owners, change the battle cry that we have become so accustomed to? Instead of bragging about how we escaped the IRS, perhaps we can start bragging about all the strategies we have implemented in pursuit of profit.
So how do you get started with a Profit First approach? Start with what Profit First Professionals call “small plates.” Money comes into your main income account, and that account acts a serving tray from which you will disperse money to other “small plates” at set intervals. Each account has a different purpose. The basic accounts you need to begin this process are income, profit, owner’s compensation, taxes and operating expenses. Advanced users usually have additional “plates,” but getting these foundational accounts set up is a great place to start.
Next, you should begin allocating money based upon the percentages you’ve set for yourself. Allocate first, then pay your bills. In a Profit First model, money moves from your income account to your profit account, then to owner’s compensation. Next, it should go to taxes and lastly to operating expenses. If you don’t have enough money to cover all of your expenses after filling the other “plates,” that’s a sign that you need to eliminate something.
A few tips to get you started: You’ll likely be tempted at first to take “extra” money from your profit account to cover expenses. Put mechanisms in place to make it more challenging to access that money and hold yourself accountable. “Borrowing” from yourself will only cause more problems down the road, so it’s helpful to remove temptation. Lastly, get in a rhythm. Setting and sticking to a schedule of allocating and paying bills the same number of times per month will help you establish a routine, and it can also provide a clear picture of your cash flow.
This new equation, “sales less profit equals expenses,” could support the next generation of entrepreneurs in their disruption efforts.