Because there aren’t really many readable business finance books out there, it makes sense that folks, if they read anything on the topic at all, are going to latch on to the most accessible of the bunch.
In many corners of the business ecosystem, the one book that someone has read about finance is Profit First by Mike Michalowicz. It’s a book with acolytes, so I thought, as a human with a financial services and advisory practice, to let you know why I don’t recommend this book!
Let me back up though and explain the gist of the system.
There are two interlocking systems embedded within Profit First:
- A system of (usually 5) linked bank accounts. One is your main checking account, where you receive all income, the others represent “buckets” for payroll, profit, taxes, and operating expenses.
- Target percentage allocations to bucket corresponding to your bank accounts to guide how to divide up your income. This is ostensibly a classic Envelope Budgeting system, but instead of envelopes of cash, you’re using various bank accounts. So when you receive income, you divvy it up according to percentages: 10% for profit, 45% for payroll, 25% for OpEx, etc…
The “Profit First” bit describes the forcing mechanism of allocating a percentage of revenue to profit first, which constrains what can be allocated to payroll and other expenses.
So rather than treating profit as the trickle down change at the bottom of your P&L, you’re planning for it by constraining your expenses to what you can afford after profit. Which can lead to some ruthless streamlining.
And, that’s not a bad thing necessarily! It’ll for sure fix your cash flow.
But that brings me to the two biggest issues with the system (or where I see folks get stuck):
Setting up a complicated bank account based system and then not actually keeping to it.
This is 95% of you. According to Profit First you should receive income and then allocated it out to 4-5 bank accounts to then pay various expenses from (or save as profit).
We, your friendly neighborhood bookkeepers, rarely see people adhere to the system with much discipline, which means you’ve got the overhead of all these accounts and they’re just sitting there making it harder to manage your finances. A lot of you hoard money in these ancillary accounts; I’ve seen a lot of owner pay accounts accumulating tens of thousands of dollars without any money moving out.
Getting stuck in the system.
The whole beginning of the book— a number of really stressful sounding cataclysmic stories— really calls it out: Profit First is a triage system for fixing cash flow. And the basics of it can actually work really well in this regard: when used at the right moment, it will force constraints and conservatism into your model. You’ll have to make some tough choices, cut expenses, and it can indeed build cushion back into your model.
Here’s the thing though: the system, yes, forces profit, but through aggressive constraints around spending. But this method doesn’t necessarily create a functionally profitable business model…it just creates cash flow. Now, again, not a bad thing! Cash flow is extraordinarily important, and not having cash flow is worse than not having profit. But…there are problems with running your business like this long term.
I hate this analogy, but it’s the most apt one I can think of:
Profit First is the pre-wedding crash diet of business finance.
All those bridal magazines helping you fit into the dress. Constraints abound! But then…imagine sticking with a wedding dress diet forever? Again, this is a wildly messed up analogy, but I hope you feel my ppoint.
You might be thinking, wait a minute! If Profit First is fixing your cash flow, doesn’t that also fix your previously unprofitable business model?
If you get stuck in this system (which again: triage system) it will continue to constrain your business. I have seen folks impede generative growth and useful risk taking because they’ve become too beholden to the model.
The two things that I recommend that are echoed (somewhat) in the book:
Every dollar has a job.
Your (business) pie really does add up to 100%
Understanding the system of how money moves through a business is key to unlocking high quality decision making.
I meet with a lot of folks who feel like the money in their business— meaning, how it flows— is just happening to them, even though money is always traveling along pathways of decisions you’ve made.
So understanding how your decisions impact the movement of money is crucial.
That every dollar has its job (whether you’ve intentionally assigned it one or not) is a really useful concept in reversing the “this is just happening to me” feeling, because it makes choices very concrete.
Have more than 1 bank account (but you definitely do not need 5).
For most folks to start, 3 is the perfect number: your main checking account for ins and outs. A tax savings account to save for estimated and any annual tax payments. A savings account to allocate profit to.
Finally, I’ll end by stating for the record that isn’t really a criticism of Mike Michalowicz, per se. His mission is “entrepreneurship simplified”. True to mission, what I appreciate about Profit First is that it’s a business finance book that people actually read! The TLDR of my critique is not to get stuck in an emergency triage system when you’re business is in a better place.