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Breaking Down Profit First Principles and Pay Yourself First

Breaking Down Profit First Principles and Pay Yourself First

Writen by:

Tim Jedrek

Business Entrepreneurship Finance Profit First

Traditional business accounting often prioritizes expenses and reinvestment, leaving profits as an afterthought. However, the Profit First methodology, developed by Mike Michalowicz, challenges this conventional approach. By fundamentally shifting your perspective, Profit First empowers you to prioritize profit as the lifeblood of your business. This article explores the core principles of Profit First and the crucial concept of “Pay Yourself First”.

1. The Profit First Paradigm Shift

  • Reversing the Equation: Instead of determining profit after expenses, Profit First dictates that you allocate a percentage of your income to profit before any other expenses are paid.
  • Income Allocation: Income is divided into five distinct accounts:
    • Income: All revenue generated by your business.
    • Profit: A predetermined percentage of income is allocated to this account.
    • Owner’s Pay: A designated percentage for your salary or owner’s draw.
    • Taxes: Allocate funds for estimated taxes to avoid surprises.
    • Operating Expenses: Funds for running the business (e.g., rent, salaries, marketing).

2. The Power of Pay Yourself First

  • Prioritizing Profitability: By prioritizing profit from the outset, you instill a culture of profitability within your business.
  • Improved Financial Discipline: The forced separation of profit and operating expenses encourages disciplined spending and prevents overspending.
  • Increased Motivation and Confidence: Knowing you are consistently generating profit boosts your confidence and motivation as a business owner.
  • Enhanced Financial Security: Regular income from your business improves your overall financial security and provides a more stable income stream.

3. Implementing Pay Yourself First

  • Determine Profitability Targets: Set realistic profit targets for your business.
  • Allocate Income Accurately: Divide your income into the designated accounts (Profit, Owner’s Pay, Taxes, Operating Expenses).
  • Track and Monitor: Regularly track your income and expenses to ensure you stay on track with your Profit First allocations.
  • Adjust as Needed: Regularly review and adjust your profit targets and allocations as your business grows and evolves.

4. Beyond Profit: Building a Sustainable Business

  • Reinvested Profits: While prioritizing profit is essential, reinvesting a portion of your profits back into the business for growth and development is crucial for long-term success.
  • Continuous Improvement: Regularly review and refine your business processes to increase efficiency, reduce costs, and maximize profitability.
  • Build a Strong Team: Invest in a skilled and motivated team to support your business growth and achieve your long-term goals.

Conclusion

By embracing the Profit First principles and prioritizing “Pay Yourself First,” you can transform your business from a source of stress to a reliable source of income and financial security. By focusing on profitability from the start, you lay a strong foundation for a sustainable and successful business.