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 rarely is one; 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 catering firm in Hatay runs everything through one account and is always busy and short of money. The owner opens four accounts and, twice a month, moves three percent of income into profit, a set share into her own pay and a fifth into tax. The operating account is suddenly small, so she renegotiates with her meat supplier and drops two dishes that cost more than they earn. At the end of the quarter the profit account holds money for the first time.
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.