The traditional GAAP formula for calculating business profit is: Sales - Expenses = Profit. However, this approach often leaves profit as an afterthought for many small business owners who base decisions on their bank balance. The Profit First Accounting (PFA) method challenges this by prioritizing profit. In PFA, a predetermined percentage of profit is taken from each sale first, and the remaining amount is used to cover expenses. This means securing profit first and then operating the business with the remaining cash. As Michael Michalowicz, the proponent of PFA, puts it, it's about choosing between treating profitability as leftovers or securing a healthy share upfront. He asserts that the PFA system, when followed, can make any business permanently profitable from the next deposit onwards.
As many small business owners can attest, the key to success isn't just about the amount of revenue generated, but rather how much of that revenue is retained as profit. It's crucial to prioritize profitability and make it the primary objective of your business. The Profit First system can significantly enhance any business by shifting the focus to profitability. Starting a business with just a brilliant idea, your unique skills, and available resources is indeed a remarkable feat. However, there comes a time when the business becomes a daunting, cash-consuming entity. Cash flow issues are a common problem for many small businesses. The typical solution is to aim for growth - increase sales, attract larger clients, and boost revenue. However, growth is only part of the solution. If your costs increase proportionally with your growth, your financial situation won't improve. The real key to a healthy small business is increased profitability, not just growth. Many small business owners resort to what's known as "bank balance accounting". This involves checking your bank balance daily to gauge your financial health. If there's money in the bank, you feel secure and relaxed. If not, you scramble to make more sales to generate cash. This is known as the "Recency Effect", where decisions are made based on the most recent information available. While it may seem natural to base decisions on your current bank balance, this approach can be detrimental. You may find yourself in a Survival Trap, constantly dealing with one financial crisis after another. The Survival Trap lures you into the illusion of quick wealth. However, it often blinds you to the significant opportunity costs involved. Instead of mastering one thing and delivering it efficiently, you end up diversifying and becoming less efficient at each step, making your business increasingly expensive to run. The Survival Trap often justifies making money at any cost, even if it means delaying payments to suppliers or taxes. The illusion of success is further reinforced by bank balance accounting, which suggests that as long as there's cash at hand, everything is fine. However, the real issue lies in the Generally Accepted Accounting Principle (GAAP) maxim: Typically, you might think like this: Start with your top line sales, the revenue you bring in. Subtract the wholesale costs of your products. Subtract all other costs incurred in running the business: rent, utilities, insurance, commissions, etc. Pay your taxes. Take your salary. Post whatever is left as your profit. GAAP encourages you to focus on sales and expenses first. The logic is that if you sell enough, everything else will fall into place. However, GAAP can be overly complex for a small business and can lead to the Survival Trap. To escape the Survival Trap and transform your small business into a cash-generating machine, you need to make a firm decision. Starting today, run a profitable business and make everything else secondary to that goal. Commit to focusing on profitability. The only way to fix your financials is by facing them. You can't ignore them or delegate them to someone else. You need to take control of the numbers. The good news is that the process is straightforward. Regardless of the size of your business or how long you've been surviving from paycheck to paycheck, you are about to become profitable. The Profit First method is a simple formula: Sales - Profit = Expenses. This approach involves taking your profit first and then scaling your expenses to match that goal. This method can help business owners create their own profit margin from day one, instead of allowing expenses to grow faster than the business. It's a cash management system that can help you plan for the future, improve your company's financial health, and make your operations more profitable.
book.moreChapters
