THE PROFIT FIRST FORMULA
The GAAP (Generally Accepted Accounting Principles) formula for identifying a company's profit is Sales - Expenses = Profit. It is pretty simple and clear. Sadly, it's a lie. The formula, while rationally accurate, does not account for human behavior. In the GAAP formula profit is a leftover, the last consideration, something that is a nice surprise at the end of the year. Sadly, for a lot of businesses, the profit is hardly ever there, and the business continues on its payroll to payroll survival. Sales - Expenses = Profit.
When we have our strategy session, I’ll talk about how with Profit First you’ll flip Expenses with Profit, and the formula will read, Sales - Profit = Expenses. Realistically the math is the same; however, from the perspective of the business owner's behavior, it is drastically different. With Profit First, you take a predetermined percentage of profit from every sale, and only the remainder is readily available expenses. This small shift in your thinking will have big effects.
Here’s why we say, “Where’d All the Money Go?”
Author and historian C. Northcote Parkinson theorized that our demand for a resource increases to meet the supply of it. That is why when we are given two weeks to do a project, it takes two weeks, and when we are given eight weeks to do the same project, it takes eight weeks. That is why when given $1,000 to complete our work, we get it done with $1,000, and when given $10,000 to complete the same work, it takes $10,000. Profit First makes Parkinson’s Law an asset. By taking profit first the money available for expenses lessens, and we are forced to find ways to get the same things done for less money.
BANK BALANCE ACCOUNTING
Most entrepreneurs don't have the time or spirit to read the different accounting statements necessary to manage the financial aspect of their business. Theoretically, you should review understand your Income Statement, Balance Sheet, and Cash Flow Statement at least monthly, but few entrepreneurs do. Most resort to "bank balance accounting," where we check our bank balance every day and make financial decisions based upon what we see.
Per Parkinson's Law, we consume what we see in our bank account. Profit First encourages the entrepreneur to continue "bank balance accounting" by first allocating money to profit (and other accounts) so that the entrepreneur sees the actual portion of deposits that are available for expenses and they automatically adjust their spending accordingly. Reviewing the Financial Statements and a cash-flow forecast bring tremendous insight. Implementing Profit First brings structure and control over expenses.
The next step in learning more is working with me to review your Instant Profit Assessment. During this Strategy Session, you'll see where you could be by allowing Profit First to drive your cash-flow system.