You’ve heard me talk about the Profit First system before and how taking a profit before paying expenses is important for business owners. At Kickstart Accounting, we help our clients implement Profit First or decide how they can prioritize getting paid as the business owner so profiting becomes a habit. 

In today’s episode, I’m going over everything you need to know before you implement Profit First into your business including the negatives, positives and variations of Profit First that you can start today.  

In this episode, Danielle also discusses: 

  • What is Profit First? 2:09
  • The 5 bank accounts you need to have 5:05
  • The right time in your business to implement Profit First 8:30
  • The main issues we see with business owners implementing Profit First 8:57
  • The steps you need to take to start making profit a priority in your business 14:02
  • Why you need to prevent burnout to create more efficiency 19:48

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Full Episode Transcript:

Intro  0:00  

Welcome to entrepreneur money stories, the podcast for women entrepreneurs who want to dig into their money stories so they can break free from limiting beliefs around money once and for all hosted by Daniel Hayden, owner of kickstart accounting, Inc. This podcast is a series of real conversations about money mindset with valuable and action packed takeaways for the entrepreneur who’s building their abundant empire. Danielle is a reformed corporate CFO who’s on a mission to help rural breaking female entrepreneurs understand their numbers and gain the confidence to create sustainable profits. And now here’s your host, Danielle Hayden.

Danielle  0:40  

Welcome back to another episode of entrepreneur money stories. We have been asked so many times throughout the years, how do we implement profit bursts in our business? Our clients have wanted to know all about profit first and how its implemented in their business. So we are here today to walk you through how we have helped our clients implement Profit First, all of the lessons learned and there is a lot of them here and strategies that you can use today in your business whether or not you want to use Profit First in your business. So first off if you’ve never heard of Profit First, the Profit First method is a new approach to cash flow management that helps entrepreneurs ensure that they make a profit and are paid. I love this part. This method was created by Mike McCalla wits and his book Profit First, Mikey created several successful businesses but proceeded to lose the business due to profit and cash flow issues out of a desperate need to make changes and create cash flow. Mike created the envelope system or also known as profit first. Now I want to disclose here upfront that profit first does not replace the need for accounting. It does not help you understand your financial performance and the levers you can pull from to improve. It is purely for cash flow management. So Profit First is cash flow management only. So traditional methods of accounting are set up to show you sales minus expenses equal profit. Now, Mike McCalla Watts methodology reverses the equation and reverses the psychology behind accounting to help entrepreneurs see sales minus profit equals expenses. Now, I realized that traditional accounting wasn’t built for humans, it was designed for number crunching robots, or accountants. Generally speaking, the results are the same no matter which equation you use, but they are very different psychological effects of this method Mike talks about in his book, The Parkinson’s Law. So this is linking our behavioral psychology and accounting. By flipping this accounting equation on its head, it causes us to prioritize profit, instead of taking what’s left. This reframing forces us to think differently about how we spend money. Now, Mike uses an example of toothpaste in the book and I do suggest everybody to read the book, Mike is actually hilarious. I have seen him speak several times. So his audible books are actually pretty funny to definitely check out the whole book, but I wanted to give you a few examples directly from the book. So Mike uses the example of toothpaste. So when we buy a new tube of toothpaste, we generally use a pretty liberal application when we go to brush our teeth, right? I don’t know why. Why do we feel like we need this much toothpaste, especially when once we actually put the brush back under the water puppet falls down the drain. But we have plenty more, right? There’s so much more toothpaste, we don’t really care yet, when the toothpaste is almost empty, our behavior is completely different. We have scarcity, right? We work so hard to extract every little bit of toothpaste that’s left inside the tube. Now I know you’ve all done this. Don’t roll your eyes. I know you’ve done this, we squeeze and we wring it out until we can get this little blob, a little bit of toothpaste that we treat like gold and brush our teeth. In other words, when we have less we are more frugal. Mike applies the same methodology to finances, business owners will typically spend money and take whatever is left over as their profit. Now by flipping this on its head and putting my profit first, the rest of the money is budgeted for it because of expenses. This forces you to think deeply about every spending decision, and it forces us to innovate by creating better output with less resources. The system simply involves transferring a percentage of allocations of you Your deposits, so all the revenue that’s coming into your bank into various bank accounts. So when our clients install Profit First in their business, there’s a few steps. First, there’s open several bank accounts, Mike had five laid out in the book, but we’ll talk about later about some additional accounts that you might want in your business. But we’ll start with five. The first one is profit. This account is used to accumulate your profit. Next, we have owners pay, which is used to accumulate dollars for wages, we have our tax savings account, which is used to save to pay our annual taxes, then we have our operating account, which is used to pay the operating expenses of the business. And then we have our revenue account, which is used for incoming revenue deposits. And I actually suggest if your bank offers this option to actually physically name each of your accounts, sometimes it’s just an option online. If not, I definitely suggest you name them in QuickBooks so that you know exactly what you’re allocating. And with step two is to determine the target allocation for each of the buckets, we’ll get into this more. And then step three is to actually create the transfers two times per month. Sounds pretty simple, right? And when I first read this book, I actually really resonated with Mike system. As a teenager, I had several envelopes, heart envelopes, where I would store my savings safely away for different purposes. I saved for vacation, a car, rainy day and spending. Now I can attest to the power of making small deposits into these funds into these accounts, in my case, little envelopes, every time I got paid, or every time I went and babysat. Now I did end up buying my first car, I did go on the vacation. And I even invested what I had saved for a rainy day and with the stock market. So even with my success, and all the success that I’ve seen with my clients, why am I still wary of this method? Here are some of the scary stories that we’ve heard from our clients. First and foremost, fees, there are gonna be so many fees associated with this, we have seen depending on who you bank with, there might be fees associated with each of the bank accounts. Now, even if you find a bank account that offers you some free savings accounts, we have seen some of our clients incur overdraft fees. I know this is due to the funds being mismanaged. This is why it’s so important that if you’re going to do Profit First, you really jump in with both feet, you really need to be so disciplined about where you’re spending money from each account. Otherwise, it’s going to completely defeat the purpose. And you’ve just created a lot of admin work with no benefit and possibly a cost associated with it if we’re overdrawn from those accounts. Alright, so what are some of the other issues. So the other issues are mindset. Now, Mike talks about in the book, the ideal percentages based on your revenue and a methodology in order to get to that percentage. However, we have seen so many of our clients be so defeated, that they can’t achieve the percentages that are laid out in the book. Now I appreciate what Mike was doing here. He wanted to lay out a very specific system in very specific numbers, because that’s what we’re looking for. Right? When we pick up a book, or pick up a system or a new methodology. We want specifics, we say, tell me how it is right. What do I need to do? Where do I what do I What are the numbers that I need. However, this can really hinder our mindset, this can cause us to have some mindset issues, because we can’t achieve these percentages that I don’t think every season of your business is the right time to implement profit. First, you might be in a season of your business where you are working on investing in growing in your business, you might be a true startup. And so this might not be the season for your business to start jumping into a new system, a new methodology that was going to require you to move these funds around this time. And it doesn’t mean that it’s never going to be the right season of your business. But understanding is this the right season of your business right now in order to implement this system. Alright, another issue that we’ve seen our clients over the years is cutting the wrong costs in order to be profitable. If you read the book, there’s a lot of information about cutting costs and prioritizing profit. I want you to get paid as a business owner, however, we have to understand what costs were cutting and are they the wrong costs in order for us to be where we want to be In our business today, if you’re a longtime listener, you’ve heard me say over and over again, not all profit is created equal. So letting go of your staff, canceling dues and subscriptions, and doing everything yourself just so you can be profitable, is not going to give you long term success in your business. However, creating long term systems, getting the right hope, and creating efficiencies will help you be profitable over time. All right, I have two more issues. And then we’re gonna get into all the ways that if you are ready to implement profit, first, the strategies that we’ve used to see our clients succeed, so tomorrow, sometimes there’s a cash lag in our business, one issue that we’ve seen with our clients is that they don’t have the cash to transfer, we actually set up these percentages. And when it comes time to transfer the funds every two weeks, the cash is not there to transfer. Now, there’s several different reasons for this cash lag, it could be large credit card payments, so the expense that was incurred was actually last month, two months or three months ago. And therefore when the credit card payment came due, we did not have the cash to transfer to our different big accounts, because we were paying our credit card, another cash lag could be we are invoicing our clients. However, we have not gotten paid yet. And so we might have to pay our staff members or purchase inventory. Before we’ve gotten paid in full from our clients. There could be other reasons for our cash lag. But one of the major issues that causes mindset issues is not having the cash to transfer. So it’s just something to be aware of. And the last issue that we see with Profit First is having a sole focus on cash, without seeing the big picture, right, we need to understand our taxes as they’re going to be filed at the end of the year for our tax return, we need to understand our financials, in order to see where our businesses bed, where our business is going. We cannot solely focus on cash, and this cash management system without understanding our accounting. So a lot of times what we’ll hear from clients who haven’t started working with us yet, it’s usually new clients who come in and say, I’ve been operating profit first for years, I love it. So I don’t know that I need a bookkeeper, I don’t know that I need an accounting system, I promise you Profit First is not going to set you up to understand and be able to read the story your financials will tell you if you have the proper accounting systems in place, with the proper financial reports to really understand your numbers to really understand where your business is going. And really able to analyze some of the things that we’re going to talk about next. So by having the proper accounting systems in place, we can actually improve our profit first methodology, I am confident that profit first and traditional accounting have a place in this world together, where we can use both systems to our advantage and really create an optimized system. Alright, so we have decided that profit versus is for us, we want to start to think about how we can use Profit First in our business. Now you hear me say this all the time. We don’t have to implement every part of a system in our business, we can take pieces and strategies from the system and choose what works for us in our business. So as you listen to this, this podcast today, this is simply to pique your curiosity. I want you from here to read the book and to talk to your bookkeeper before you implement it. However, if you’ve listened so far, and you are interested in getting yourself paid, and prioritize grading a profitable business, then I want you to keep listening. So how do we ensure success? What are some of the steps that we need to use in order to create this profit for our system? So first and foremost, when we are creating the accounts, we have to make sure that we actually create all the accounts. Now I’ve heard from people throughout the years, there’s some fees associated. I’m not going to create all five accounts, I’m only going to create two. Well, that’s not how the system is laid out. And it is very difficult to manage the funds from only two accounts. This is the one rule from the system. I do think we need to follow consistently by having separate accounts and name them so that it’s clear for you and your bookkeeper to understand what the funds are used for. The next step to ensure success of launching Profit First is to meet with your bookkeeper to ensure that you have the right allocations going to the right accounts, especially your tax account. This is where we have really been able to help our Lyons, we have to understand what our current allocation percentages are today? Right? So before we even implement the system, what are we allocating to owners’ pay? What is our current profit percentage? How much are we spending on operating expenses? What is our current tax rate, we have to see what our current allocation percentages would be today, so that we have a starting base to be able to work from once we understand what they are today, we can grow by small amounts over time, rather than jumping into the allocations that are prescribed in the book. So understand where you are today and make small increases over time. You’ll hear me say this all the time. I want you to believe in small changes. This is where the magic is, there is no overnight success. Well, there are videos that go viral. But there are not overnight successes, especially in entrepreneurship. Next, when you’re working with your bookkeeper, you have to determine what is the right compensation salary for your business today, in the near future. This can be reviewed annually and increased over time, but you have to understand what you have been paying yourself? And what is the right salary for your business under your current operation. Now, I do appreciate that Mike prioritizes getting you the business owner paid, you aren’t in business for you, you are in business for your business to serve you, not for you to serve your business. You, the business owner cannot live on or below minimum wage as an owner operator. So let’s understand what we’re being paid today. What our business can afford to pay us today. And then plan by small changes where we want to see our percentage allocation go moving forward. Next, we need to look at our tax return to determine our current tax rate. So you’ll see all the steps is to understand where we are today before we launch and move forward. So understand your tax return and determine your current tax rate. Next, we need to understand our expenses and determine what expenses can be cut. When we do this with our clients, we pull the profit and loss or also known as the income statement report. So here we’re operating in a world where profit first hand accounting, traditional accounting cannot work together. So by pulling our profit and loss statement detail, we can look at the expenses that we have incurred historically, to determine what we need moving forward. Now while we do this exercise with our clients, we use our expense grading worksheet that I would like to offer all of you to use to help you determine what expenses can be cut. The expense grading worksheet is a way of listing out all of your current operating expenses. And actually grading each one, a B, C, D, like we’re back at school, but this time you got to be the teacher and design. Are you using those expenses in your business? And do you need those tools in order to be able to operate efficiently moving forward? Next, polling that same Profit and Loss report, look at our payroll costs. Who are we paying today? And how are we currently assessing our team and their performance in the business today? So again, we’re going to marry our profit loss statement to the Profit First system, and look at our operating expenses. In the p&l, the profit and loss. First, understand what our current allocations are today, before we decide where we’re going. Remember that 95% of your company’s profitability is contingent on what happens below your revenue line. So we have to understand the income statement in its entirety. To understand how we can be more profitable, we need to chip away at the expenses and let go of the dead weight. We have to understand our profits. And remember, not all profit is created equal. As we assess our owners’ pay and payroll for our team. We have to remember, as we look at our owner’s pay and the payroll of our team, we can ask ourselves a few questions if we are profitable, and the amount we’re paying our team is minimal. Are we overworked and approaching burnout? Is this a long term strategy? Now this is very different from what Mike talks about in profit first. So if you read the book, this is a variation to his approach in Profit First, Mike has a system of being frugal, taking over more tasks as a business owner and operating really efficiently. However, this is where we differ. I want you, the business owner, to prevent burnout. I want you to prevent being overworked. So are we spending enough money to continue to grow, to set up a team and a set of efficiencies to be able to continue to build our business. Now these efficiencies might look like team members, they might look like systems. And they might look like standard operating procedures, creating the most efficient way to operate your business so that you are profitable, yet not approaching being overworked, or burnout. Now, this is a lot of work right? before we just jump in. Before we go bigger, go home, I want you to give yourself some grace and go slowly. Don’t get bogged down in all the details and that start, let’s work with our team, work with our money team to understand what our current percentages are. And then give ourselves grace and move slowly working towards prioritizing profit working towards prioritizing getting ourselves paid. Get your mindset right, like Henry Ford said, If you think you can, or you think you can’t, you’re right. So stop telling yourself what’s not possible. And start telling yourself, let me think about that issue. Let me think about how to make this more efficient. Let me think about that problem. And let me find a way to solve this problem, or create more efficiency in my business. So this isn’t about slashing payroll costs, slashing expenses, and then pulling funds out as operating salary and profit. It’s about creating the most efficient business so that we can find a sustainable balance between operating expenses, profit, and owner’s pay. Now this process is only going to happen, that we learn how to work on our business instead of in our business, having a dedicated time to meet with your money team, to review your financials. And to go through these details to be brave enough to ask yourself these questions, be brave enough to do things differently, to create efficiency in your business, and to solve problems. one other issue that we’ve heard from our clients is that the biggest five accounts aren’t enough. I know, right now, you

might be thinking that’s funny five accounts seems like way too many. However, there might be other bonus accounts that are needed. And the reason that these bonus bonus accounts exist are so that we can save for big expenses over time. I know I sound like a broken record, we don’t have to do things overnight, we can save for expenses with small amounts moving 1% towards our goal, and these other accounts are able to be created to support that growth. So the money is set aside in a separate envelope. Now some examples of this that we’ve seen our clients use is that we have several of them. So some of them are the bolts or an OSHA account. So this is a one to three months worth of operating expenses to help cover any thing that comes up that we were not expecting a debt repayment account for large stock purchases. So if you have to restock inventory in the future, prepare for that now before it comes up. Before we have to end up putting that on a credit card and paying for it later. Let’s start to prepare to look into the future instead of being reactive to pass through cost. So maybe you’re paying for something for a client or clients paying something paying you for something that you will then later have to pay a vendor for any materials for future events or future supplies. A large equipment purchase commission if we want to be able to give our team a commission, or employee bonuses end of the year or mid year, preparing for those throughout the year, we want to have a cash management system set up so that we can make business decisions knowing that we have the cash in order to be able to pour back into our business. And the last one is sales tax sales tax isn’t always paid monthly. And so being able to prepare for sales tax payments, I know this can feel really heavy. Money is a hard topic. You are really brave for pressing play today. I am so proud of you for being willing to dive into this information. This podcast here today is to pique your curiosity and to be able to pull some tools and strategies, ideas from Profit First, that you can implement in your business. So talk to your money team about where you are today. And how you might be able to make small movements, small efficiencies, small savings to work towards a future where you have more profit in your business, and you’re taking home more money as a business owner? If you liked today’s episode, all we ask is that you hit like and subscribe. Share this episode with one other entrepreneur who you know needs support in their business. Until next time. Hey podcast lovers, I hope you’re enjoying another amazing episode of entrepreneur money stories I had to tell you about an exciting new tool we recently launched. If you’ve been wanting to learn how to start managing your business finances, but don’t know where to start, then visit kickstart accounting to receive our new five day video bootcamp series, you’ll receive a video each day that will take you from accounting overwhelm to money powerhouse. So you’re ready go to kickstart accounting

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