Whether your SMB is established or you're a novice business owner, it stands to reason that making a healthy profit is a top priority. But there's more to analyzing your bottom line than just finding new ways to increase revenues or decrease expenses. Here's how to redefine the way that business owners look at accounting functions and explore what's happening behind the numbers.
Accounting & Finance — Not to Be Ignored
According to Forbes, 82% of enterprises fail because of poor cash flow management. Business owners always need to keep a watchful eye over their cash flow, which can get overlooked while they're focusing on increasing their reach, improving their product, finding the right talent, and other concerns that frequently result in never-ending to-do lists. Moreover, once businesses start to grow, many SMBs and startups make the fatal mistake of not investing enough into their accounting and finance resources. This is often due to only seeing accounting as a service and merely a function since it's not a revenue driver like marketing or product development.
Regardless of what stage your business is currently at, it's common to just leave everything to an outside accountant without stopping to think about what these numbers actually mean. Operations are keeping you busy, and there's only so much time and headspace to think about accounting functions and financial statements that go beyond what you are legally obligated to file with tax authorities and external capital like banks and investors. However, cash management is just as crucial as analyzing your profit or loss, and the "profit first" model is a very simple and approachable way to change your attitude about the accounting outcomes for your business.
What Is Putting "Profit First"?
The foundation of accounting figures is determining your profit, which is usually expressed by the equation Revenue - Expenses = Profit. Author Mike Michalowicz challenges this notion in his book Profit First by changing the expression to Sales - Profit = Expenses.
It may not make sense from a GAAP point of view, but it does from a psychological one.
The "profit first" model causes entrepreneurs to rethink how they view their cash flow. Typically, profit is examined as taking what is left after business expenses have been paid. But by switching profit with expenses in the above expression, it makes you more conscientious about already having "money left over" for personal and business savings, obligations like taxes, and reinvesting in your business while limiting what you put toward expenditures.
It's very similar to the "pay yourself first" mindset when you get a paycheck from a regular job: You put aside percentages of your paycheck, such as 5% to your retirement plan and 10% to your savings account, then what you have left over is what goes to your personal expenses and disposable income. Whereas if you ascribed to the traditional profit model, you would prioritize your expenses, which can result in having far less or even nothing left to save ("paying yourself" referring to building your savings).
Why Would You Put Profit Before Expenses?
Think about your personal finances for a minute. Once you have income that goes beyond your basic needs like your rent or mortgage, food, health insurance and transportation, you might stay in the habit of simply spending whatever you have left over. Even if you don't spend it all right away, you're likely not saving enough for emergencies, let alone long-term goals.
The same thing happens when you own a business: You could be concerned with product development or expansion costs on top of your burn rate while not giving any thought to having anything left over to pay yourself or reinvest in your business. For many entrepreneurs and freelancers, taxes tend to get overlooked due to prioritizing operating and living expenses. By setting hard limits on how much you're going to spend, you're taking control of your business in a way that merely going over financial accounting statements and definitions cannot do.
How Do You Devise a Profit First System?
Every business owner's needs for this will vary, but you will need to work with your bank to set up multiple accounts. Creating five accounts is a good baseline:
Savings Accounts:
Checking Accounts:
It may seem counterintuitive and overcomplicated to split your transactions into so many accounts. However, this gives you a "bird's eye" view of your cash on hand and where it's going, whereas a spreadsheet or accounting software by itself won't do it justice. Once you set aside your target allocation percentages for each account, you make deposits according to those percentages.
While this approach does not erase the need for accounting statements, expressions, and ratios, it can negate your reliance on setting personal and business budgets and improving your cash flow. Many SMBs put a laser focus on revenue drivers, profit level, and reducing expenditures but often neglect to monitor cash inflows and outflows. Putting "profit first" better allocates your funds for long-term success.
Martinez & Shanken, PLLC writes for CountingWorks, an accounting news and advice website. Reach the firm at [email protected]
About Martinez & Shanken, PLLC
Martinez & Shanken, PLLC is a Certified Public Accountant (CPA) firm based in Gilbert, Arizona. We provide a full range of accounting, bookkeeping, consulting, outsourcing and business services. Partners Deborah Martinez and Earl Shanken work to ensure your business accounting is done with integrity and to your satisfaction.
