How do you know if you have a business or a glorified job? The two areas to look at will be how much time you spend on the business and how much money you get out of the business.
This short post will focus on how much money you’re paying yourself with a quick recap of Profit First by Mike Michalowicz.
But before that let’s clear up a common entrepreneurial fallacy when it comes to finances. Reinvesting all of your profit back into an SMB should only be for a limited time. Not taking profit for over a year or two means that you have poor money management and aren’t being innovative enough.
And the only three times in a business’s life that this applies to are in the start-up phase, during a black swan, or post-acquisition, where the integration will require some capital to stabilize the business. That being said, here is your one-page recap of Profit First.
The old way of doing business is Sales – Expenses = Profit.
The right way of doing business is Sales – Profit = Expenses.
Your top-line income account should feed into 4 separate bank accounts or buckets: (1) profit, (2) Owner’s Compensation, (3) taxes, and (4) operations.
In that specific order as it translates to reward, reward, protect, and serve.
Then the allocation for each should be:
1. Profit = 10% – This is a rainy-day fund for the business or growth capital for urgent opportunities. Quarterly 50% of the profit account can be taken out to reward the owner or to pay off the company’s debt.
2. Owner’s Compensation = 10% – This is your take-home reward for taking the risk of owning a business.
3. Taxes = 15% – This is to keep Uncle Sam happy and protect you from going to jail!
4. Operations = 65% – This is the leftover to operate the business. If it can’t be done right now, you have to be more frugal and innovative!
Make your own diagrams and workflows with Lucid Charts.
The allocation and sequence are final. Taking funds from one of the 4 buckets for another one will break the system!
Each of the 4 buckets should be its own bank account. Make the profit and tax accounts difficult to access, like a 1-hour drive (your definition of a long drive) with no online access.
Sweep and allocate the money from the main income account into the 4 buckets on the 10th and 25th of every month.
This is an example of a business with $2M in top-line/sales at years end:
1. Profit = $200,000
2. Owner’s Compensation = $200,000
3. Taxes = $300,000
4. Operations = $1,300,000
This site is focused on business, but the book has a section on implementing this model in your personal finances.
Regardless of how many companies you own, implementing profits first will make your life as an entrepreneur less stressful and more rewarding. And I know that that sounded like a Starburst contradiction commercial, but it’s true!
Now back to the main question at hand do you have a business or a job? Profit First by Mike Michalowicz is one of the key steppingstones to being above the business.
And if you want the PDF version of this post get it here.