What Is Real Revenue in Profit First?

The Profit First methodology offers a distinct approach to managing business finances, moving beyond traditional accounting practices. This system centers on the principle of prioritizing profit, ensuring that a business consistently sets aside funds for its owners and future growth. A foundational concept within this framework is “Real Revenue,” which serves as the true base for financial planning and allocation. This article will explain what Real Revenue means in the context of Profit First, detail how it is calculated, and illustrate its application in the system’s allocation process.

Defining Real Revenue in Profit First

In the Profit First system, Real Revenue represents the actual income a business has available after accounting for the direct costs associated with delivering its products or services. This concept differs significantly from traditional gross revenue, which refers to total sales before any expenses. The focus on Real Revenue stems from the understanding that not all top-line sales are truly available for profit or owner’s compensation.

Profit First emphasizes that a business should base its financial strategy on what it genuinely retains, rather than solely on top-line sales figures. For instance, a construction company with $10 million in gross revenue might spend $7 million on materials and subcontractors; its Real Revenue is $3 million. This means it should operate like a $3 million company, not a $10 million one. This perspective helps business owners avoid overcommitting cash not truly available for discretionary spending or profit, supporting better strategic planning.

The specific costs deducted from gross revenue to arrive at Real Revenue are those directly linked to the production or delivery of a good or service. These include what Profit First terms “Cost of Goods Sold” (COGS), specifically focusing on materials and subcontractor expenses. For example, in manufacturing, this encompasses raw materials. In a service business relying on external contractors, payments to these subcontractors are deducted.

These deductions represent pass-through costs, meaning funds received from a customer are immediately paid out to a third party to fulfill the service or product. They are not fixed overheads or employee payroll for the business’s core staff, which are operating expenses. This distinction is crucial because these direct costs are necessary expenditures to generate the revenue itself. By removing these costs from the revenue base, Profit First ensures that percentages allocated for profit, owner’s pay, and taxes are based on income truly available to the business owner.

Calculating Real Revenue

The calculation of Real Revenue within the Profit First framework is a straightforward process to identify income truly available for allocation. The fundamental formula is: Gross Revenue minus Cost of Goods Sold/Direct Costs equals Real Revenue. This calculation provides a clear financial picture by stripping away expenses directly tied to delivering the product or service.

To perform this calculation, a business aggregates its total gross revenue for a specific period. From this, specific direct costs are subtracted. For example, if a web design firm generates $50,000 in gross revenue and pays $15,000 to freelance developers for project work, those freelancer fees are direct costs.

A product-based business earning $100,000 in sales might spend $30,000 on raw materials and $5,000 on shipping costs directly associated with delivering goods. The resulting Real Revenue would be $65,000 ($100,000 – $30,000 – $5,000). Accurately identifying and tracking these direct costs is important because misclassifying an expense can distort the Real Revenue figure, leading to inaccurate allocations.

Expenses not direct costs, such as monthly software subscriptions, administrative fees, or core employee salaries, are not included in this deduction. These are considered operating expenses and are addressed later in the Profit First allocation process.

Applying Real Revenue in Profit First Allocations

Once a business has accurately calculated its Real Revenue, this figure becomes the foundational base for all subsequent financial allocations within the Profit First system. This amount is then systematically divided into distinct bank accounts: Profit, Owner’s Pay, Tax, and Operating Expenses. This method ensures profit is a predetermined portion of income, not merely a leftover.

Using Real Revenue as the basis for these allocations is central to the Profit First philosophy. It ensures funds for profit and owner’s pay are drawn from revenue truly available to the business, rather than top-line sales inflated by significant direct costs. This approach prevents overspending or under-saving for crucial areas like taxes or owner compensation.

Profit First employs Target Allocation Percentages (TAPs), which are ideal percentages a business aims to achieve for each account. These TAPs are applied directly to the Real Revenue figure. For instance, if a business’s Real Revenue is $50,000, and its TAPs are 5% for Profit, 50% for Owner’s Pay, 15% for Tax, and 30% for Operating Expenses, then $2,500 goes to Profit, $25,000 to Owner’s Pay, $7,500 to Tax, and $15,000 to Operating Expenses. The allocation process involves transferring funds from the main income account to these dedicated accounts regularly.

This systematic division based on Real Revenue forces a business to operate within its actual means, promoting financial discipline and sustained profitability. By proactively allocating funds for profit and taxes, the system helps ensure these crucial areas are funded. The remaining funds for operating expenses then represent the true budget available for day-to-day operations, encouraging efficiency and expense management.