Concept
The Profit First formula
Mike Michalowicz reverses the accounting formula: not sales minus expenses equals profit, but sales minus profit equals expenses. Profit is taken first as a fixed percentage of every deposit, and expenses are forced to fit what remains.
The standard formula is correct and ruinous for a small business, because it makes profit the leftover and there is never a leftover; expenses expand to fill the account. The reversal is behavioural rather than mathematical. Income arrives in one account and twice a month is split by percentage into four: profit, owner's pay, tax and operating. The percentages start where the business can bear them, even one percent for profit, and rise a point at a time. Tax is set aside before it is due. Owner's pay is a line rather than what is left, which is the difference between a business and a hobby that costs money. The profit account is distributed quarterly and never raided; if the operating account runs short, the business is saying something about prices or costs, not about the system.
A real-life example
A baker splits her next deposit five percent profit, forty owner's pay, fifteen tax, forty operating. The operating account looks alarmingly small; within a month she has replaced supermarket flour with a wholesaler, and the profit account holds 900 lira at the end of the quarter.
How to use it
- 1Open the four accounts: profit, owner's pay, tax, operating.
- 2Split every deposit by percentage on the tenth and twenty-fifth.
- 3Never move money back from profit or tax; fix prices or costs instead.