Today, we will be talking about Profit First and how to pay yourself as a new business owner. If you are not a new business owner, or you’re thinking of starting your own business but haven’t done so yet, you may be asking yourself: why would I not pay myself as a business owner? It’s a good question. You assume you would pay yourself in your business, but what factors might prevent you from doing so?
When I started my business, I invested in tools, marketing and other things to grow my enterprise. I would justify spending on my business for its growth instead of paying myself. Then I would work more hours to make more money to spend more to grow the business. However, because I wasn’t prioritizing myself, it became a vicious cycle of working more and not setting aside the money that I needed to honor the time and energy that I was putting in. I know that I am not alone in this cycle; I’ve talked to many business owners who have done the same.
What is Profit First?
Michael Michalowicz wrote a book discussing the Profit First method. I’m not sure if he invented it, but his book, Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, is extremely popular. The book and method is a cash flow management tool for your company. In the same way that it’s helpful to have a budgeting and cash flow system for your personal life, it’s essential to have one for your organization, and really at the essence of profit.
As the name suggests, the number one priority is to make a profit for yourself before anything else. Because when you prioritize putting money towards expenses and investing in the business, it’s easy, as I explained earlier, to de-prioritize paying yourself a salary or paying yourself a profit, which is ultimately the goal of any business. Profit First is a mindset change. You might have said before Profit First: okay, this money, I’m going to invest back into the business when profit is available, or when I have a certain amount of profit, then I’ll get paid. After Profit First: You’re going to pay yourself first, then set aside money for taxes, and lastly, use leftover funds to re-invest in your enterprise. The order of operations is different. By prioritizing Profit First in your mind and in the order in which you move the money, it allows you to pay yourself first and give yourself profit first.
How Do You Implement Profit First?
I’ll give a brief overview because I don’t want to bore you. The book does an excellent job of explaining how to allocate funds to different parts of your business before you earn any income. Of course, this will vary depending on your type of organization. You will base your decision-making on your gross income, how much you want to pay yourself, and other factors specific to you. You may want to start with one- or two percent profit to get accustomed to what this feels like initially. You can adjust that percentage over time. You can allocate 20% of your income to business expenses, 25% to taxes and the remainder, about 53%, remains for your take-home pay. To reiterate, at the beginning of your business venture, for every dollar that you bring in at the beginning, you only have 53 cents to pay yourself. This take-home percentage may be a shock to some of you, but it’s beneficial to think about this formulation so that you don’t think you’ll be able to take home more money than possible.
Another example: if you’re only making $1,000 a month when you start your business, you will take a one- to two percent profit, which is $20. You will dedicate $250 for taxes, $200 goes towards business expenses, and the remainder is your take-home income. With that in mind, you know you can only spend $200 a month on business expenses. If you want to spend more than that, you need to earn more income first, which is not often how new businesses operate. You don’t want to justify spending more money on business expenses because you will de-prioritize yourself. By de-prioritizing yourself, you will quickly burn out and feel frustration and resentment.
I highly recommend Michael Michalowicz’s book, Profit First, if you’re looking to start your business. Make sure to read it first because it will give you a valuable roadmap to set up your venture before you’ve gotten started and save yourself a lot of time and trouble. As always, any questions that you have, I would love to hear them in the comments and welcome any suggestions for future blog posts.
This post was adapted from an episode of the Fireside Financials series. If you’d like to check out the video, you can watch it here!