If you’re struggling to turn a profit even as your business grows, it might be time to implement Profit First allocations. This powerful cash management strategy can transform the way you approach your finances and put you on the path to profitability – fast.
In this guide, we’ll show you what Profit First allocations are, how to choose the right percentages for your allocations, and how to implement them in your business.
in this article:
- What are Profit First allocations?
- Why entrepreneurs need Profit First allocations
- How to choose the right Profit First percentages
- How to set up your Profit First allocations
- Getting started with Profit First allocations
What are Profit First allocations?
Profit First allocations are an integral piece of the Profit First method, a financial management approach that focuses on prioritizing profit. Mike Michalowicz developed this method (and wrote the book Profit First) to help business owners achieve long-term success and profitability.
Basically, Profit First involves allocating your income into 5 different categories/accounts: income, profit, owner’s pay, taxes, and operating expenses. The moment you make a sale, you immediately put aside a percentage for profit. The remaining money is then split between the remaining categories/accounts and in the order listed. There is a method to this madness of multiple accounts…I promise.
The term “’Profit First allocations” refers to the act of setting aside or “allocating” the appropriate portions of your income into these categories when you earn it — not after all the expenses are paid. Instead of following traditional accounting principles, where Sales – Expenses = Profit, the Profit First accounting method flips the script: Sales – Profit = Expenses.
This ensures that a part of your revenue is always being reserved for profit, creating a built-in margin for success in your business and limiting what’s available for spending.
Example of Profit First allocations
So what do Profit First allocations look like in practice? Imagine your business makes a sale of $1,000. In the Profit First model, this money isn’t considered entirely disposable for expenses or investments. Instead, you split or “allocate” it among several defined categories.
According to Profit First’s suggested allocations, you might move the following amounts to your 5 Profit First bank accounts:
- 0% stays in the income account, this is where the income is received and from where the allocations originate
- 5% ($50) as profit
- 50% ($500) for owner’s pay
- 15% ($150) for taxes
- 30% ($300) for operating expenses
Why entrepreneurs need Profit First allocations
Profit First helps small business owners get into the habit of paying themselves first. Instead of watching your revenue get eaten up by expenses month after month, you’ll finally be able to enjoy the fruits of your labor.
Most entrepreneurs manage their finances with “bank balance accounting” — the habit of checking your bank balance and making financial decisions based on what’s in the account. Though this method may seem practical, it often leads to impulsive spending and poor cash management.
By handling the profit first, every time you receive a business payment, you’ll only spend based on what’s left in your bank account. That means you don’t necessarily have to change your “check-your-bank-and-spend” habit — you just need to set aside your profit, taxes, and other allocations first.
How to choose the right Profit First percentages
Managing your business finances can feel overwhelming, but Profit First can help simplify things. Follow the steps below to decide what percentage of income you should allocate to each of your Profit First accounts.
Examine your current situation
First, it’s important to get a clear understanding of your business’s revenue and expenses. How much are you earning on average each month? How much are you spending? Are you already turning a profit, or have your expenses become too inflated?
Get clear on your business goals
Next, think about where you want to go. Do you want to pay off debt? Hire an employee? Start paying yourself more? Whatever your goal, be as specific as possible — instead of saying, “I want to make more money,” try specifying, “I want to pay myself a salary of $100,000 per year.”
Choose your target allocation percentages (TAPs)
Now comes the exciting part — deciding on your Profit First percentages. Profit First recommends different allocation percentages based on real revenue:
While these target allocation percentages (TAPs) are a great starting point, every business is different. For example, if you run an online business, your operating expenses will be much lower than someone with a brick-and-mortar store. As a result, you may be able to allocate more to profit.
The important thing is to be realistic and choose percentages that will help you achieve your business goals — without leaving you scrambling to cover costs. Remember, you can always adjust these percentages as your business evolves.
How to set up your Profit First allocations
Once you’ve decided how much income to allocate to each category, it’s time to set up your Profit First bank accounts. Here’s a quick, step-by-step guide to help you put your Profit First allocations into action.
Step 1: Open multiple checking accounts
To get started, Profit First recommends 5 accounts:
- Owner’s Pay
- Operating Expenses
However, opening five separate bank accounts can be tricky. Your bank might have minimum balance requirements, maintenance fees, and other restrictions for business checking accounts.
Step 2: Make your transfers at least twice a month*
Profit First suggests making your transfers on the 10th and 25th of each month. On these days, you’ll distribute the money in your Income account to the other accounts based on your predetermined Profit First percentages.
*We have found however that most businesses do better when they use a weekly approach. Here’s a fun way to do that:
Book a money date, just you and money, each week (Shaneh recommends Thursdays, ruled by Jupiter, the energy of the day supports manifestation, expansion, and money) and process your allocations on all deposits that have hit your bank since the last time you did your allocations. This weekly practice will create a steady rhythm for cash flow management.
At first, it’s a good idea to handle your Profit First allocations yourself. However, once it’s become a habit, or you are finding that this really isn’t the best use of your time (not in your zone of genius) you might want to outsource to a Profit First accountant or bookkeeper.
For example, Prosperity First’s Profit First bookkeeping service is designed to help you implement and stay on track with your Profit First allocations. If you need some extra guidance, we can even help you figure out the right Profit First percentages for your business. To learn more, contact us.
Step 3: Review and adjust your allocations as needed
Profit First simplifies cash flow management, but it’s not about setting and forgetting. It’s crucial to review your allocations regularly and adjust them as your business grows. To achieve long-term financial success, flexibility and adaptability are key. This is where, if your business is ready for it, a fractional CFO becomes useful. A Profit First-certified fractional CFO will not only review your allocations but can also thoughtfully integrate considerations beyond the TAPS table—these are your numbers.
Getting started with Profit First allocations
Adopting Profit First can transform your business for the better. As you take charge of your finances and start prioritizing profitability, you’ll be able to create a more sustainable, prosperous future.
Need some extra support to get started? Here at Prosperity First, we specialize in Profit First bookkeeping for coaches, online marketing agencies, PR firms, and other self-employed service providers.
If you’re tired of traditional accountants and bookkeepers who only see the numbers and not the soul behind them, then you’re in the right place. Let me introduce myself: I’m Shaneh Woods, and I’m the CEO of Prosperity First.My passion is to help you take your business to the next level and make it f*cking FUN every step of the way. To get started, you can book a FREE clarity call with me here. I can’t wait to meet you!