Seasoned entrepreneurs are probably familiar with Michael Michalowicz and his “Profit First” system for small businesses. He wrote a book entitled “Profit First’ outlining the system and the benefits it can bring to any sustainable small business.
The Purpose of the Profit First System
The Profit First system teaches business owners to divide their incoming revenue into separate commercial bank accounts based on the usage of the money.
The five categories of bank accounts are Income, Owner’s Compensation, Profit, Operating Expenses, and Taxes. Michalowicz also suggests opening two savings accounts at an entirely different bank. These accounts will be labeled as Tax Hold and Profit Hold.
So, that’s seven bank accounts in total. Five commercial checking accounts at one bank and two savings accounts at another bank. Wow, that can be a lot to manage for any small business owner with limited time on their hands.
Is there an easier way to manage all your business finances?
The One Account Method
Start by opening one commercial checking account for your company and then download a copy of our Allocation Tracking Spreadsheet here. You won’t have to open any other bank accounts.
Direct All Company Income to Your One Commercial Checking Account
The next important step is to direct all customer payments to your one commercial checking account. If you haven’t already done so, connect all of your payment processors to your bank account. Your customers can pay your company through any of these payment processors, and the money will end up in your bank account.
As a result, all the money you receive will go into one account rather than five or seven accounts. You can also use the payment processors to pay bills using this one bank account. Therefore, all your company’s money will go in and out of this one bank account. Then it should be much easier to manage your company’s finances.
In addition, you’ll want to send payments to yourself from this bank account too. So go into your online checking account and make yourself the payee of a money transfer. It is that easy!
Tracking Your Money
You’re probably wondering how the Profit First system plays into all this. After all, this system requires you to have at least five different bank accounts. So how can you implement this system using only one commercial checking account?
Well, here’s where it gets interesting. Instead of creating multiple accounts, you are going to use the Allocation Tracking Spreadsheet “reserve money” within your one bank account. These money reserves allow you to set aside a percentage of funds for future expenses.
When you complete your allocations on the 10th and 25th of each month, you will move the money on the spreadsheet instead of transferring money between bank accounts. If you ever need to know how much money you have for operating expenses or purchases, you will review your spreadsheet instead of your bank balance since some of the money in your account is now off-limits.
Calculating Percentages
If you’ve already read “Profit First” or studied the Profit First system, then you’ll remember the concept of “TAPS” or “Target Allocation Percentages.” These are the percentages of your company’s revenue that you allocate to the other bank accounts.
The four primary allocation categories are:
Profit – 5%
Michalowicz recommends putting 5% of your company’s revenue into a Profit account.
Taxes – 15%
The general recommendation for the Tax account is a 15% allocation, but you should probably talk with an accountant for further guidance. The percentage is based on your expected income and overall tax situation.
Owner’s Compensation – 50%
Small business owners love spending money because they work hard to build their businesses. Spending gives them a sense of fulfillment and happiness. That is why a whopping 50% allocation is appropriate for Owner’s Compensation. Once you start growing your business more, you could increase this percentage.
Operating Expenses – 30%
30% is a fair percentage for operating expenses. Of course, you could always adjust this percentage after seeking guidance from an accountant.
Understanding Target Allocation Percentages
How much money do you need for your personal expenses? If you can answer this question, you can figure out how much you need to take home from your business revenue.
Don’t cut yourself short, though. You should take enough to live the comfortable life you want to live.
For example, if your business generates $10,000 per month in revenue and your personal expenses are $6,000 per month, you would need to take up 60% of your revenue.
$6,000 / $10,000 = 60%
The 60% would apply to your Owner’s Compensation.
– Profit – 5% ($500)
– Taxes – 15% ($1,500)
– Owner’s Compensation – 60% ($6,000)
– Operating Expenses – 20% ($2,000)
You may have to reduce your company’s operating expenses, but that’s okay. Most companies spend more than necessary, which could put them out of business if they aren’t careful. So if you can find a way to run your company with minimal operating costs, you can increase your Owner’s Compensation and help ensure your business stays viable for a long time.
Using the Reserve Funds
Let’s get back to your Allocation Tracking Spreadsheet. Once you’ve calculated the proper allocation percentages, transfer the funds from the income section to the allocation section on the spreadsheet. While all the money is still in one account, it is essentially transferred to your spreadsheet.
The Profit First system requires separate accounts to prevent you from spending money prematurely. The Allocation Tracking Spreadsheet serves the same purpose as having multiple bank accounts.
Remember that all of your money is still technically in one account because the money doesn’t leave your checking account. Instead, it just gets separated into the reserve funds within the same account.
Conclusion
Every new and existing small business should use the Profit First system for its financial management. But if you need further guidance, it is always a good idea to consult an accountant about the best target allocation percentages.