What Is Profit First? A Method for Business Profitability

The Profit First methodology offers a distinct approach to financial management, fostering consistent profitability. Unlike traditional accounting that calculates profit after expenses, Profit First prioritizes profit allocation from every deposit. This cash management strategy guides businesses to proactively set aside funds for profit and other purposes before operational spending. Its fundamental premise is to ensure a business is profitable by design, rather than by chance.

Core Principles of Profit First

The Profit First methodology is built upon core principles that challenge conventional financial thinking. A central concept is Parkinson’s Law, which suggests that demand for a resource expands to meet its supply. In business, available funds tend to be spent, regardless of necessity, if not intentionally allocated. Profit First counteracts this by taking profit first, reducing the supply available for discretionary spending.

Another guiding idea is the Law of Primacy, emphasizing prioritizing what is most important. By allocating profit first, the system instills a habit of prioritizing the financial health and sustainability of the business. This is achieved through systematic allocation, distributing predetermined percentages of incoming revenue into distinct categories. This strategy involves setting up multiple, separate bank accounts for different financial purposes, allowing clear segregation and management of funds.

Setting Up Your Profit First Accounts

Implementing the Profit First methodology begins with establishing a specific banking structure. Businesses typically set up five foundational bank accounts: Income, Profit, Owner’s Pay, Tax, and Operating Expenses. The Income account serves as the initial deposit point for all incoming revenue before funds are distributed.

The Profit account is for the business’s actual profit, ensuring funds are set aside and not inadvertently spent. The Owner’s Pay account holds compensation for the business owner(s), promoting consistent remuneration. Funds for tax obligations, such as estimated federal and state income taxes, flow into the Tax account, preventing last-minute payment challenges.

The Operating Expenses account holds funds for day-to-day operations, and all operational bills are paid from it. Business owners contact their bank to open these separate, clearly labeled accounts.

Implementing the Profit First Methodology

With dedicated bank accounts, the Profit First methodology involves a consistent process of money allocation. A key element is the “allocation day,” typically occurring twice a month, often on the 10th and 25th. On these days, all revenue collected since the last allocation, residing in the Income Account, is systematically distributed.

This involves transferring predetermined percentages of total income from the Income Account into the Profit, Owner’s Pay, Tax, and Operating Expense accounts. For example, if a business receives $10,000 in income, and the Profit allocation is 10%, $1,000 moves to the Profit account. All business expenses, from rent to supplies, are paid exclusively from the Operating Expense account, reinforcing financial discipline. This regular transfer ensures profit, owner’s pay, and tax obligations are addressed before general spending.

Understanding Your Profit First Allocations

Determining financial divisions within the Profit First system involves assessing a business’s financial health and goals. This begins by understanding Current Allocation Percentages (CAPs), which reflect how revenue is utilized. An assessment involves analyzing historical financial data to calculate what percentage of income has historically gone towards profit, owner’s pay, taxes, and operating expenses.

The aim is to move towards Target Allocation Percentages (TAPs), representing ideal percentages for each account based on industry benchmarks and revenue level. Rather than drastic changes, the methodology advocates for small, incremental adjustments towards TAPs. For instance, if current profit allocation is 2%, a business might gradually increase it by half a percentage point each quarter until the target is met. These percentages require periodic review, typically quarterly or annually, to adapt to changes in revenue, growth, or economic conditions, ensuring the system remains effective.