Profit First - BOOK SUMMARY
"Transform Your Business from a Cash-Eating Monster to a Money-Making Machine"
• Why following four principles can simplify accounting and make it far easier to manage a profitable business by just looking at bank account balances.
• How taking your profit first both enforces frugality and inspires industry-changing innovation.
• That a small, consistently profitable business can be worth much more than a large business that struggles to sustain itself.
Your Business Is an Out-of-Control Cash-Eating Monster
No matter how many years you’ve been at the grind, you are probably well aware of the statistic that roughly 50 percent of businesses fail within the first five years. What they don’t tell you is that those failed entrepreneurs are, in fact, the lucky ones! The majority of businesses that survive are racking up debt, and their leaders are perpetually stressed. Most entrepreneurs are living a financial nightmare. Stitching together a business with nothing but a great idea, your unique talents and whatever few resources you have at hand is a miracle. And it feels like one, too, until the day you realize your business has become a giant, scary, soul-sucking, cash-eating monster. No amount of talent, ingenuity, passion or skill will change the fact that cash is still king. Master the essence of financial security: Save your money and block access to it so it doesn’t get stolen — by you. Bigger Is Not Better Growth is the battle cry of nearly every entrepreneur and business leader. But growth is only half the equation. Most business owners try to grow their way out of their problems by hinging salvation on the next big sale or customer or investor, but the result is simply a bigger monster. Entrepreneurs assume that at a certain point, their revenue will yield a profit. Profit is always within sight but never attainable. What they don’t realize is: Profit is not an event. Profit is a habit. The Core Principles of Profit First Quick fixes for weight loss don’t work and aren’t sustainable. What we really need are simple lifestyle fixes that change how we eat without our even really noticing. For example, use smaller plates. If you reduce the “plate size” of your business’s operating account, you will spend differently. So rather than curb your spending habit, create the experience of having less cash on hand than you actually have and then find ways to still make things work. The Four Core Principles of Profit First 1. Parkinson’s Law. In 1955, a modern philosopher named C. Northcote Parkinson came up with the counterintuitive Parkinson’s Law: The demand for something expands to match its supply. In economics, this is called induced demand. The more we have of something, the more we consume.You need to intentionally make less money available to operate your business. When there is less, you will automatically run your business more frugally, and you will run your business far more innovatively. 2. The Primacy Effect. We place additional significance on whatever we encounter first. When we follow the conventional formula of Sales - Expenses = Profit, we are primed to focus on those first two words, Sales and Expenses, and treat Profit as an afterthought. We then behave accordingly. We sell as hard as we can, then use the money we collect to pay expenses. We stay stuck in the cycle of selling to pay bills, over and over again, wondering why we never see any profit. When profit comes first, it is the focus, and it is never forgotten. 3. Remove Temptation. As you implement Profit First, you are going to use the powerful force of “out of sight, out of mind.” As you generate a profit, you are going to remove the money from your immediate access. You won’t see it, so you won’t access it. And just like anything that you don’t have a reasonable degree of access to, you will find a way to work with what you do have and not worry about what you don’t. 4. Enforce a Rhythm. When we get into a rhythm, we don’t get into the reactive mode of crazy spending when we get big deposits and panicking in the face of big cash dips. Establishing a rhythm will get you out of the daily panic. In fact, establishing a rhythm will also be a great indicator of overall cash flow. Instead of reading the cash flow statement, you can measure your cash flow by just checking your bank accounts. But If I Set Aside My Profits, How Will I Grow? The fastest, healthiest growth comes from businesses that prioritize profit. And it is not because they plow money back into their businesses. Businesses that plow back their profits aren’t truly profitable; they are just holding money temporarily (feigning profit) then spending it, just like any other expense. Taking profit first will help you figure out which of the many things you do makes money and which don’t. Then the direction is obvious — you do more of what is profitable, and you fix (or dump) what is not. You will focus on what makes profit for you, and you will get better and better at it. And when you get better at what your customers already want and like, they will like you more. All this translates into fast, healthy growth. The New Accounting Formula The next step is to put a system around the normal you. And we start with a simple, new Profit First formula: Sales - Profit = Expenses Here’s how you apply the four principles: 1. Use Small Plates. When money comes into your main INCOME account, it simply acts as a serving tray for the other accounts. You then periodically disperse all the money from the INCOME account into different accounts in predetermined percentages. Each of these accounts has a different objective: One is for profit, one is for owner compensation, another is for taxes and another is for operating expenses. 2. Serve Sequentially. Always, always allocate money based on the percentages to the accounts first. Never, ever, ever pay bills first. The money moves from the INCOME account to your PROFIT account, OWNER’S COMP, TAX and OPERATING EXPENSES (OPEX). Then, you pay bills only with what is available in the OPEX account. No exceptions. And if there isn’t enough money left for expenses? This does not mean you need to pull from other accounts. It means that you can’t afford those expenses and need to get rid of them. 3. Remove Temptation. Move your PROFIT account and other tempting accounts out of arm’s reach. Make it really hard and painful to get to that money, thereby removing the temptation to “borrow” from yourself. Use an accountability mechanism to prevent access except for the right reason. 4. Enforce a Rhythm. Do your allocations and payables twice a month (specifically, on the 10th and 25th). Don’t pay only when there is money piled up in the account. Get into a rhythm so that you can see how cash accumulates and where the money really goes. This is controlled by recurring and frequent cash-flow management, not by-the-seat-of-your-pants cash management. IF YOU'D LIKE TO READ MORE OF THE BOOK SUMMARY [WRITTEN BY SOUNDVIEW EXECUTIVE BOOK SUMMARIES] IT'S AVAILABLE ONLINE AT HTTPS://STATIC1.SQUARESPACE.COM/STATIC/55DBFCCEE4B08731143170B6/T/599C8B296F4CA3531891A15B/1503431468072/PROFIT+FIRST+-+MIKE+MICHALOWICZ.PDF