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£10,184.17 – That was the number that jumped out of the email from Nathan, my accountant. It was the 4th January 2017. My tax bill was due.
I was running a freelance business and the return was a little later than I expected because Nathan had been off with a knee problem. I saw that number in the email and I couldn’t breathe.
You know, when you get that tunnel vision feeling and you just fixate.
I didn’t have £10,000. It was due in 27 days, and I couldn’t pay it. It was on that day, that I vowed that that was never going to happen again. There was never not going to have enough money for a bill that was pretty much predictable. Granted, it was the first payment on account. And I didn’t know what payment on account was (I do now)
It was around about that time that I found this book. Profit First by Mike Michalowicz. It’s changed the way I run my businesses. And I really refer back to it, you can see how many post it notes I’ve got.
Hi, I’m Hazel. If you’re new to my channel, I help trade businesses become more efficient, and more profitable. I run a plumbing business and I run a consulting business, training people how to use job management software to run their businesses more efficiently, more profitably, and get their weekends back.
In this video, today, I’m going to take you through three things, three parts of this book, we’re going to go through the core principles. We’re going to talk about getting it all set up. And then thirdly, putting it into motion. Let’s do it.
So you might be thinking, why do I need somebody called Mike to tell me how to run my business and put money aside for my tax bill? Well, basically, businesses are cash eating monsters, the vast majority of businesses fail within the first one to three years. And they’re failing, because they can’t manage their money properly. The traditional formula for calculating profit is revenue, minus expenses equals profit. But what Mike suggests is that you take that formula, and you turn it on its head, and you say, revenue minus profit equals expenses. So you take your profit first. You guarantee you’re going to hit a minimum level of profit. And you work with the rest as your pot for expenses.
Profit, first, in a nutshell, is the idea of taking your revenue, and on a regular basis, splitting it out into relevant buckets. And those buckets are profit, tax, owners compensation (your wages), and expenses. And the really key thing here is that the expenses part comes last. And so your business needs to move towards being able to work off the expenses that are left. After you’ve taken that profit, you’ve taken the tax out, you’ve taken your compensation, what you’re owed, for running your business, and making it your life’s work. And then your expenses come last.
It uses a number of principles, and a number of human psychologies. To reinforce why this works. Mike talks about Parkinson’s Law, he talks about the Primacy Effect. And he talks about the dieting industry a lot, because a lot of the principles of having a healthy balanced diet are the same.
When it comes to managing your business to really understand what’s going on here, it’s useful to refer back to something called Parkinson’s Law. So, Parkinson’s Law states that demand increases to match supply. The idea being that if you have a large pot of money that you are managing your business out of, then mentally you will think I’ve got that amount of money to play with. Whereas if you take out your profit first, and your expenses pot is smaller, then you will naturally find ways of being more inventive, and getting more out of your business for less money. If you think about the way a tube of toothpaste works, and the reckless abandon that you squeeze toothpaste onto your toothbrush at the beginning of a new tube of toothpaste, and then compare that with what you’re doing at the end when you get close and you squeeze it out and eke it out for ages is the same principle.
So the next principle that’s really important here is something called the Primacy Effect. So we as humans have a habit of focusing on the thing that we read or see or do first. And so, if expenses come out first we focus on expenses. Whereas if we focus on Profit First, we focus on the minimum amount of profit that we want to make. And that’s where the primacy effect comes in, it’s changing our focus, making sure that we’ve got our eye on the prize. And that means that our business is serving us, rather than us serving it.
So the next principle of why this works, is the idea of removing temptation. So you take your profit, you put it away, if you can’t see it, it’s a bit like hiding your chocolate bars, or not even buying them in the first place, leaving them in the shop. If you can’t see it, then you’re not tempted to spend it. And what tends to happen when you’re running a business is you steal profit from yourself, you borrow money from, you know, money that’s there, that’s supposed to be profit, at the end of the day, anything, oh, well, I had a few more expenses this time, or I had a few more expenses this month, I’ll just, I’ll just take a bit of the profit, I’m investing in my business. This can happen more and more often, and you never pay it back. So by removing temptation, the idea is that you’re taking the profit, and you’re putting it elsewhere where you can’t see it.
So the final principle is the idea of enforcing rhythm. So much as we have kind of regular mealtimes, we can do this with money too. By enforcing a rhythm of allocating the money into the right places, it means that you get a balance. And you can start to predict what your revenue’s going to do, and how much money you’re going to have put aside. You can start to work towards improving those percentages and changing the split of profit and expenses in your business so that you can fundamentally put the profit percentage up and keep working on pushing the expenses percentage down.
Okay, so in this next section, we’re going to talk about how you actually get this set up. Now, this book was written in, I think, 2014. At the time, Mike suggested setting up multiple bank accounts. So if I refer to the book, he suggests that you set up five checking accounts, which in the UK is current accounts. So you set up an income account, or profit account, owners compensation account, a tax account, and an opex account. Opex is operating expenses.
So he suggests that you set up five accounts and then you go to another bank, and you set up two more, no temptation accounts. So these are your profit hold, and your tax hold.
Periodically, you will take the money that you’ve gathered in your profit account and your tax account, and you shift them out of sight, i.e. out of sight out of mind, into these two, no-temptation accounts, so that you can’t see them.
When this book was written, the idea of setting up seven different accounts was probably a bit of a nightmare. And your accountant and your bookkeeper would be tearing their hair out. But with the rise of companies like Starling bank, monzo, tide, I’m sure there are multiple others, you can now set up basically pots within one account.
This allows you to have one bank account, and where all of your money comes into and you can then do your allocations. You can put your money aside into those different pots so that you’re doing exactly that. But you have the simplicity of one bank account. And I do actually wonder whether the owners and founders of Starling and Monzo actually read this book.
So every two weeks or every month, you take the revenue that’s coming into your business, and you split it down into the appropriate percentages. So let’s say you wanted to make 10% profit, you put 10% profit aside in one pot, then you’ve got your tax that you need to pay. And that’s probably depending on where you live going to be an average of between 20 and 30%. You’ve then got your owners compensation, so your wage for running your business and your expenses. And that’s what’s left for you to run your business on. So by breaking your revenue down into these parts, and making sure that you take your profit first and then allocating everything else accordingly, you end up working with a smaller pot for your expenses. And that focuses your mind. Mike says that there are four steps to put it into motion.
Number one, tell your people so you need to get your accountant and your bookkeeper on board with this method, have a chat with them and really bring them on board and get them to understand what you’re trying to achieve the results will speak for themselves.
Step two, you need to go and set up your accounts. So as I said, Starling, Monzo, (other accounts are available) will allow you to set up one bank account, and then have multiple pots. So you can either go do that, or you can look at setting up different bank accounts to manage your five different income accounts.
Then your to hold accounts, your no temptation accounts. So how you do that is completely up to you will – it’ll completely depend on your business and your situation and your current bank account.
Okay, so step three, is you have to decide your allocation percentages. So I thoroughly recommend that you get the book, Mike provides guidance, including examples and worksheets, and really lays things out in terms of what percentages are going to suit your business to start with. And the idea is that you can change these percentages, as you get used to the method and you bring your expenses down, you can put your profit up and really play with them. So you need to get your allocation percentages, decided making your first distributions, and Mike recommends to get into the rhythm, you do it twice every month. He suggests the dates, the 10th of the month, and the 25th of the month, because then you’ve got that balanced distribution of money, so that you’re not going for long periods without moving the money into the places that it needs to be.
Mike’s fourth step, as part of putting this into motion is to celebrate your first day in your first set of allocations, because it’s a big thing, you’re on a new path.
So it’s worth bearing in mind that you’re probably going to need to cut your expenses. I think what it highlights is the health of your business. And if your expenses are way higher than your allocation percentages allow, then you really need to take a close look your expenses. If you’ve got debt, you need to deal with that. And so you can adjust the percentages and really start small, don’t be put off by expenses being too high or having lots of debt is a reason to not go ahead and get started, because once you get into that rhythm, you’ll really begin to see the momentum.
So that’s it for today. Don’t take this summary as a way of avoiding buying the book, I would definitely recommend that you go buy the book, you work through it, you assess the health of your business, and then you get started with it.
It’s made such a massive difference for me for my peace of mind for my understanding of how cash moves through my business, for clarity on how much tax I need to have put aside.
So you might be wondering, Well, what happened to that £10,184.17.
I actually made a phone call. And I spoke to HMRC. And I explained that I hadn’t been expecting that size of bill. I explained that I couldn’t pay it. And the solutions opened up, they allowed me to do a 12 month payment plan. They said that as long as I had the amount cleared by the time the next bill was due, then it was all good with them.
There were no black marks, there was no problem.
If you don’t want to implement Profit First in your business, that’s absolutely fine. But one thing I would say that if you could take this away from the video, is if you end up with a large debt, if you owe a large amount of money and you don’t know how to pay it, then be honest. Ask for help.
Phone & speak to whoever it is you owe that money.
Explain the situation.
Be honest with them.
You would be surprised at the solutions that come your way. Things that you think aren’t even possible might be possible. If you are honest, you tell them before the money is owed. And you explain the situation. Burying your head in the sand when you have a large bill is never the right solution. Honesty is always the best policy when it comes to debt. There is no shame in having made a mistake and not have the money aside. But you can learn from it. You just have to be honest. Ask people for help tell people what’s going on. And you will be surprised at the support that comes your way by doing that.
I hope this has been helpful. I thoroughly recommend that you go by and read this book. It might even be available in your local library.
It’s been a game changer for me, and I think it will be for you too. Thanks, bye!
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