Table of Contents Hide
- How Does Profit First Work?
- What does Profit First Percentages mean?
- Who Should Employ the Profit First Strategy?
- How to Put Profit First into Action
- #2. Calculate your Profit First percentages (CAPS and TAPS)
- Pros and Cons of using the Profit First Method
- How can Profit First accounting help your small business?
The profit first method is a revolutionary approach to cash flow management that assists entrepreneurs in making a profit and getting paid.
As counterintuitive as it may appear, entrepreneurs are notorious for not paying themselves appropriately and on time too. Hence, the profit first percentages assist small business owners in carving out their own slice of the pie.
But, how exactly? In this article, we’ll look at the Profit First method, how it works and who should adopt it.
How Does Profit First Work?
Profit first requires business owners to deduct their gain from cash deposits before expenses rather than rewarding themselves with the remainder. Pre-determined percentages of your cash deposits are sent into multiple bank accounts to cover profits, taxes, running costs, owner’s payments, and income.
The different categories of the profit first percentages are as follows:
- TAP: Target Allocation percentages decide how much money you invest into each account
- CAPS: Current Allocation percentages represent how your Real Revenue is currently spent.
Here’s how many percentages you should allocate to each account
- Profit range: 5% to 20%
- Owner’s Pay: 0% to 50%
- Taxes: 15%
- Operating expenses range from 30% to 65%.
The percentages will differ depending on your firm, your total revenue, and how you currently spend your revenue. The more your firm earns, the more you’ll set aside for profits and business costs, and the percentage set aside for the owner’s pay may likely fall.
See This: VARIABLE OF INTEREST: Definition, types and examples.
What does Profit First Percentages mean?
Choosing a bank that supports Profit First is critical to the success of your company’s Profit First implementation.
That is why profit first percentages provide insight into your company’s existing financials and a process for achieving future financial objectives.
While the Current Allocation percentages assist you to understand how your financials are now being allocated between income, owner’s compensation, operating expenses, profit, and taxes.
TAPS are the percentages of your financials that you want to split in order to increase profitability, cash flow, and business growth.
Develop your business with these percentages but ensure you select a business bank that does not charge minimum balance fees and allows you to open multiple accounts at no additional cost.
Who Should Employ the Profit First Strategy?
Those who should employ the profit first strategy include small enterprises, entrepreneurs, and solopreneurs. This is because in most cases, they don’t have the same access to finance as big corporations. Hence, they reinvest all profits to grow the business.
This makes it tough to produce a profit year in, and year out and this leaves the company unaided in difficult times.
If you’re having difficulty simplifying your financial tracking, you may direly need the Profit First method.
It has assisted countless business owners in increasing their profitability and cash flow.
How to Put Profit First into Action
Below are the various ways you can put the profit first percentage into good use. Be it in your business or financial decisions.
#1. Establish smaller spending categories
The first step to take is breaking down how you spend your money into smaller other buckets. Meanwhile, a bucket is a grouping of comparable assets. Depending on your company’s primary function, your buckets are the five bank accounts relying on them.
- Profit and Loss Statement (Savings Account)
- Accountant for Taxes (Savings Account)
- Owner’s Compensation (Savings Account)
- Revenue (Transaction Account) (Transaction Account)
- Expenses for Operations (Transaction Account)
Now, consider each bank account as a bucket and your money, the water. It is expedient to note that you may require a few extra accounts but start with the first five and expand from there.
Read This: ADVERTISEMENT EXAMPLES: Best Advertisement Examples
#2. Calculate your Profit First percentages (CAPS and TAPS)
There are two kinds of percentages you require to establish your present financial situation and define your profit first gals. They are: Current Allocation Percentages and Target Allocation Percentages.
While the former reveals where your real revenue is being spent on and what your company is buying daily, the latter outlines where your real revenue should go after the business is functioning efficiently and profitably. And, these are the ideal percentages you should strive for.
The idea is to gradually transition from CAPS to TAPS. However, you won’t reach these percentages immediately and you won’t be able to work towards them unless you know what they are.
#3. Make a Cash Transfer
In your income account, you can deposit all of your earnings into it and make it a habit to do so regularly. It is entirely up to you to decide how frequently this should happen.
On the 10th and 25th of every month, you can put money into the Profit, Taxes, Owner’s Pay, and Expense accounts.
Many business owners believe they must adhere to the 10/25 rhythm exactly, but this is not the case.
Only ensure you adhere to whatever rhythm you choose.
#4. Make your payments
Pay your bills with your Profit First accounts. The idea is to make sure that each account is used for its original purpose and below explains what each account stands for.
- Profit Account: This account accumulates a very modest sum ‘off the top’ that can be used for debt reduction, emergencies, or to reward yourself for all your hard work. Because the Profit First formula is big on making money, this account comes first!
- Owner’s Pay: This account is used to pay your salary or what is due to you after taxes. It will be in your best interest to resist the urge to re-invest this in your business because it is your salary. Remember, you must be compensated!
- Taxes: Use the Tax Account to meet all of your tax and superannuation responsibilities.
- Operating Expenses: This is the total amount of money accessible to your company for operating expenses such as office supplies, marketing, meals, and business travel. It is expedient you spend it wisely. However, you’ll need to address the issue if you don’t have enough money to cover your running expenses.
#5. Review your Profit First system at the end f each Quarter
profit First percentage system requires that you re-evaluate every aspect of your business strategy, including your accounting systems and personal financial status.
As things take a new shape, so will your need for cash, and your account transfers should reflect this.
Pros and Cons of using the Profit First Method
The Profit First strategy is a wonderful way to improve your business but you need to determine whether it is appropriate for your organization. It is simple and straightforward to apply.
Your profit column on your Profit & Loss statement will show an instant result.
However, there are many disadvantages to consider.
Profitability is not something that everyone is comfortable with in their business, for example:
When a profit-based decision is applied overnight with no prior training on how things are done, your staff may find it difficult to adjust or, they may simply give up.
Profit First can be challenging to accomplish for short-term businesses such as status, especially if profit is measured in terms of monthly cash flow.
Because you need the firm going right away, you may not have enough time or money to invest in training your employees on how profit works and why it is vital.
How can Profit First accounting help your small business?
There is always a tendency for our money to fit whatever is given to us. This is what the Profit First method accounts for but the traditional accounting and bookkeeping strategies do not.
By designating funds for profits at the outset, you ensure that your business, even as a startup, will be lucrative.
Using the Profit First strategy teaches you to be more disciplined as well.
That doesn’t imply you have to be stingy with your money in order to manage a business. It means being more deliberate about which resources and expenses have the biggest positive impact on your organization.
In other words, focus your efforts on what has the greatest impact.
The Profit First method is a way of paying yourself first, then your bills. It is often referred to as ‘pay your workers before you pay anyone else.’
While there are pros and disadvantages to employing this technique right now, we recommend considering it now for increased profitability in 2022.