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Profit First (by Michalowicz) - Does it work?

Scot

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The book Profit First by Mike Michalowicz was recommended through two podcasts I listen to, EOFire and Soloprenuer Hour. I decided to grab the audio book and check it out. Not only was it pretty funny to listen to, it was a really interesting take on business accounting.

The basic premise of Profit First is that we keep track of our revenue and cash flow by utilizing different bank accounts and pull Profit out of our revenue before doing anything else.

It works with the psychological understanding of how people perceive money and resources. Instead of complicated GAAP accounting that the average person cannot understand, you have 5 accounts to hold money. Each account gives you a realtime view of how much money you have.

The accounts:
  • Real Revenue
  • Profit
  • Taxes
  • Owner pay
  • Operating Expenses
All accounts receivables flow into the Revebue account. Twice per month, you automatically allocate predetermined percentages into each account.
IMG_6534.jpg
This way you don't take money that should be paid to Uncle Sam and use it to pay bills. The other big part is that you take money for yourself. This follows a common practice that MJ talks about, Pay yourself First.

The psychology used here is similar to using smaller plates to control food portions. If you have less money in your Op Ex account, you won't overspend.

And by paying yourself first you don't kill your spirit by buying a job (a bad paying one at that)

Has anyone read this book or heard of Profit First?

Does anyone use this to run their business?

When I get to the point to where I open a bank account and start looking at actually collecting revenue, I'm very interested in implementing this.

Curious to see everyone else's thoughts on this.
 

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MidwestLandlord

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Interesting. Never heard of that. I like the psychological side of it for sure...

For my main business, we use a CPA. So I guess I don't really have that kind of control there. (she uses GAAP)

For my other stuff, I'm married to my accountant...pretty sure if I got away from GAAP she would murder me in my sleep haha. (not joking)

The biggest problem I see besides uptight accountants, is that all profits go back in right now to grow the business. I guess this could be used when you actually start taking draws or a salary?
 

Nicoknowsbest

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This is awesome, thanks for sharing @Scot!

I actually started doing something similar recently.

Despite the extra cost of having multiple accounts, I currently have several and it really helps.

I'll look into structuring my business accounts in a similar fashion like you mentioned - maybe there is a way to do that without opening equal, charged accounts.

Maybe there is a solution to have a virtual structure? Will check with my bank.

Thanks for the book hint, will also look into that!
 
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For my other stuff, I'm married to my accountant...pretty sure if I got away from GAAP she would murder me in my sleep haha. (not joking)

The biggest problem I see besides uptight accountants, is that all profits go back in right now to grow the business. I guess this could be used when you actually start taking draws or a salary?

It's kinda funny you mention that. My wife, before she went to medical school, got a degree in accounting. We talked about the book and she was curious about the methods used. With GAAP, it's kind of shady, because there are so many ways to just input numbers in a different way (all legal) to show different profits. Enron was showing profit while they declared bankruptcy.

Your second part, about reinvesting profit back into the business is one of his big rules in the book. NOT to use your profit for growth.

They way he explains it, as your business brings in more revenue, the margin between expenses in your Op Ex account and gross revenue will grow, and THAT money is used to grow the business.

I know I've over simplified this book and I'm by no means an accounting major, but the way he explains it totally makes sense.


This is awesome, thanks for sharing @Scot!

Despite the extra cost of having multiple accounts, I currently have several and it really helps.
Many banks you can actually negotiate the cost of these extra accounts or remove minimum required balance.

I'll look into structuring my business accounts in a similar fashion like you mentioned - maybe there is a way to do that without opening equal, charged accounts.

Maybe there is a solution to have a virtual structure? Will check with my bank.

Thanks for the book hint, will also look into that!
With the virtual part, the author really pushes against that. There are actually more accounts in the system than I put above. The main point of having actual separate accounts (some of which are at different banks) is to prevent you from touching it.

It's not just a system to help organize finances, it's a safety measure to keep you from effing it up.
 

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I have heard of the book and it is on my reading list. I'm sure that it has come good information in it however, I see issues with the problem that @MidwestLandlord said.

The biggest problem I see besides uptight accountants, is that all profits go back in right now to grow the business. I guess this could be used when you actually start taking draws or a salary?
If you are doing 0-250k there is no way that you should be taking 50% for owners pay. The model doesn't account for trying to grow quickly. I didn't take money out of my business to live on for over a year because it would have hindered early growth. I only take money out now as I am required to by law and I take the minimal amount that I can.

Adding separate accounts also means that my accountant has to reconcile more and charges me more. I might see this in a more passive business but in a young, fast growing active company I don't see this being an effective use of capital.
 

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They way he explains it, as your business brings in more revenue, the margin between expenses in your Op Ex account and gross revenue will grow, and THAT money is used to grow the business.
Meaning as the contribution margin dollar amount increases, and fixed costs remain the same, then there is more money to play with.

Hmmm...

Except at some point the relevant range of fixed costs changes, as your fixed costs increase with scale. (typically)

I see what he means, but not sure how it's really different from just plain ol' basic bookkeeping and cost analysis.
 

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Adding separate accounts also means that my accountant has to reconcile more and charges me more. I might see this in a more passive business but in a young, fast growing active company I don't see this being an effective use of capital.
Scale brings these issues though. I have 13 different bank accounts.

"Eggs all in one basket" and all that...
 

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Scale brings these issues though. I have 13 different bank accounts.

"Eggs all in one basket" and all that...
Agreed that scale always has more accounts. I have multiple accounts at several banks but adding specific accounts for these purposes would draw that number up above where it should be IMO. I think the allocation of funds that is shown in the table is a bigger issue than the multiple accounts though.
 

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I guess if its helpful for your personality/situation then fine, but this kind of stuff screams gimmick to me. JMHO.
 
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If you are doing 0-250k there is no way that you should be taking 50% for owners pay. The model doesn't account for trying to grow quickly. I didn't take money out of my business to live on for over a year because it would have hindered early growth. I only take money out now as I am required to by law and I take the minimal amount that I can.

Adding separate accounts also means that my accountant has to reconcile more and charges me more. I might see this in a more passive business but in a young, fast growing active company I don't see this being an effective use of capital.
For the 50% that is a Target. They way he says it in the book is to evaluate all the activities you do in the business. Based on your revenue, how much would you be able to pay someone to do those things? That's your pay check. The percentages in the above chart are not hard rules.

I don't know if this system would work in a $10 million + business. But, for a business with 10 or less employees, it seems plausible.

Meaning as the contribution margin dollar amount increases, and fixed costs remain the same, then there is more money to play with.

Hmmm...

Except at some point the relevant range of fixed costs changes, as your fixed costs increase with scale. (typically)

I see what he means, but not sure how it's really different from just plain ol' basic bookkeeping and cost analysis.

He uses the toothpaste tube analogy. If you have a full tube, you cover your brush with paste. If you have an almost empty tube, you do everything possible to get those last few squeezes out and the tube manages to last a whole week.

The psychology this method utilizes is that if you have less money to work with, you're going to be hyper aware of every dollar you spend and can lean out your business.


I guess if its helpful for your personality/situation then fine, but this kind of stuff screams gimmick to me. JMHO.
How so?

Keep in mind, I am by no means evangelizing this. I found the book refreshing and enjoyable and I'm doing my best to summarize a somewhat complex accounting practice in a single forum thread.
 

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CareCPA

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I guess if it helps you not spend all your money on operating expenses, and still have some to pay yourself and your taxes, then it would help.
My bigger concern is why are you pulling out an amount for "Profit" and just leaving it in a bank account? Why wouldn't you allocate it to either "owner pay" or reinvest in your business? It seems like this would cause you to have a bunch of idle cash sitting around.
 

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Gonna weigh in here given that this = pretty much my 9-5 job. I like the psychological aspect of it, and there are definite limitations to GAAP, and I'm not going to argue about when you should/shouldn't draw. Here's my problem with this: it's simple. If your business is a podcast or blog it might be sufficient, but if you're shipping a physical product, especially to distributors, it'll go straight to hell.

So a couple items:
  • GAAP profit overstatement: The most common cause of this that I've seen is that folks don't properly accrue their liabilities,... because it's tedious. Here's the thing though, going through the process, especially at first, helps you get your finger on the pulse of your business.
  • P&L vs cash flow forecasting: In addition to a monthly P&L, I also have a pretty robust desktop forecast model (which I won't go into, and probably wouldn't be useful to most people here), and a 12 week cash flow planner. Do this. It will help you keep track of the liabilities you have hanging out there without the hassle of GAAP accruals. You can leave that to your CPA at year end.
Here's how you build the sheet:
Starting cash balance +
Cash In (separate lines for AR/open orders/forecasted sales) -
Overhead expenses incl wages and insurance by line (actual AP + forecasted) -
Cogs expenses (actual AP + forecasted)-
Other expenses (actual AP + forecasted) =
Ending cash balance

That grid goes out at least 8 weeks. 12 is better.

Separate section below for random items where you know you'll be spending money but aren't sure exactly how much and when.
 
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Gonna weigh in here given that this = pretty much my 9-5 job. I like the psychological aspect of it, and there are definite limitations to GAAP, and I'm not going to argue about when you should/shouldn't draw. Here's my problem with this: it's simple. If your business is a podcast or blog it might be sufficient, but if you're shipping a physical product, especially to distributors, it'll go straight to hell.

So a couple items:
  • GAAP profit overstatement: The most common cause of this that I've seen is that folks don't properly accrue their liabilities,... because it's tedious. Here's the thing though, going through the process, especially at first, helps you get your finger on the pulse of your business.
  • P&L vs cash flow forecasting: In addition to a monthly P&L, I also have a pretty robust desktop forecast model (which I won't go into, and probably wouldn't be useful to most people here), and a 12 week cash flow planner. Do this. It will help you keep track of the liabilities you have hanging out there without the hassle of GAAP accruals. You can leave that to your CPA at year end.
Here's how you build the sheet:
Starting cash balance +
Cash In (separate lines for AR/open orders/forecasted sales) -
Overhead expenses incl wages and insurance by line (actual AP + forecasted) -
Cogs expenses (actual AP + forecasted)-
Other expenses (actual AP + forecasted) =
Ending cash balance

That grid goes out at least 8 weeks. 12 is better.

Separate section below for random items where you know you'll be spending money but aren't sure exactly how much and when.

I understood about 5% of what you said. Maybe that's why Profit First appealed me to. Realistically, I need to hire an accountant once I get to that point.
 

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My bank setup highly mimics this for both personal and business.

I started doing this with personal accounts several years ago with accounts at Chase and AllyBank. I set it up as "goals" on my personal accounts. Later I revised the strategy to fit my business accounts. It's not the exact same as what's posted, but pretty close and the end result is pretty much the same.

I don't deal in physical products much ( other than testing the waters ) so this has worked out for me great the last few years being digital.
 

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I'm no CPA, nor do I play one one on TV. But I do have a friend that runs a local restaurant, and I've heard advice like this from him on several occasions. He keeps fund divided among bank accounts and before he pays a bill, he pays himself...even before paying taxes. The mindset is such that he gets paid, no matter how well the business is doing. The business could tank, but he's getting paid. I have insufficient experience to comment further on how well it works, but he's still in business!
 

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...The business could tank, but he's getting paid...
Depending on how he is set up, he may shoot himself in the foot.
If he's racking up losses, but still taking a wage, he could end up running through his basis and not be able to take the losses on his taxes against the wages he's reporting. A fairly common occurrence: I've seen plenty of business run through their basis and not understand why they can't take the losses on their taxes.

All this to say, it doesn't matter how you allocate your dollars, you still need to run a solid business to be able to pay yourself. The rest is just psychological tricks.
 

Nicoknowsbest

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With the virtual part, the author really pushes against that. There are actually more accounts in the system than I put above. The main point of having actual separate accounts (some of which are at different banks) is to prevent you from touching it.
Definitely makes sense, thanks for clarifying.


It's not just a system to help organize finances, it's a safety measure to keep you from effing it up.
I totally agree.

Even the toughest discipline mindset gets cracks sometimes.

I literally locked myself out of some accounts.


Many banks you can actually negotiate the cost of these extra accounts or remove minimum required balance.
Would you suggest to have these accounts within one bank, or spread out over several banks?


Adding separate accounts also means that my accountant has to reconcile more and charges me more. I might see this in a more passive business but in a young, fast growing active company I don't see this being an effective use of capital.
While I agree, I also decided to hire an accountant despite running a young company.

I believe it's worth the couple more bucks to be set up to win.

I'd rather save a few hundreds on my office equipment instead.


Scale brings these issues though. I have 13 different bank accounts.
Ha, that's a lot :)

It's always funny when standing at the supermarket cashier and fetching the right card.

After you run through 4, or even 5, people behind you start taking a few steps backs :)
 
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Would you suggest to have these accounts within one bank, or spread out over several banks?
In the book he recommends 2 banks. The main bank has your 5 accounts and the second bank should be inconvenient to access. This is where you stash your money for taxes so that you don't touch it.
 

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The book Profit First by Mike Michalowicz was recommended through two podcasts I listen to, EOFire and Soloprenuer Hour. I decided to grab the audio book and check it out. Not only was it pretty funny to listen to, it was a really interesting take on business accounting.

The basic premise of Profit First is that we keep track of our revenue and cash flow by utilizing different bank accounts and pull Profit out of our revenue before doing anything else.

It works with the psychological understanding of how people perceive money and resources. Instead of complicated GAAP accounting that the average person cannot understand, you have 5 accounts to hold money. Each account gives you a realtime view of how much money you have.

The accounts:
  • Real Revenue
  • Profit
  • Taxes
  • Owner pay
  • Operating Expenses
All accounts receivables flow into the Revebue account. Twice per month, you automatically allocate predetermined percentages into each account.
View attachment 14779
This way you don't take money that should be paid to Uncle Sam and use it to pay bills. The other big part is that you take money for yourself. This follows a common practice that MJ talks about, Pay yourself First.

The psychology used here is similar to using smaller plates to control food portions. If you have less money in your Op Ex account, you won't overspend.

And by paying yourself first you don't kill your spirit by buying a job (a bad paying one at that)

Has anyone read this book or heard of Profit First?

Does anyone use this to run their business?

When I get to the point to where I open a bank account and start looking at actually collecting revenue, I'm very interested in implementing this.

Curious to see everyone else's thoughts on this.
Actually it's very logical to limit your amounts even if your earnings are good.
An interesting fact to note, reading earlier books like the Pumpkin Plan and Toilet Paper Entrepreneur (I actually prefer Pumpkin Plan, TPE has bland fluff) reveals his background story. The author did sell off his earlier venture for millions, but he mentions he blew his nest egg on wastage. Thought he was invincible.

But I think he did not need to blow a fortune to write a business book!

His experiences would have led him to formulate Profit First as a means to fill this weakness.
If you observe the real revenue range in the 50 millions range, most of the cash is diverted to the business maintainence rather than owner pay. This is in line with Fastlane UCL investing in our own business. I'll give Mike that.

I understood about 5% of what you said. Maybe that's why Profit First appealed me to. Realistically, I need to hire an accountant once I get to that point.
The real acounting mechanisms aside, actually it is simple.

  • GAAP profit overstatement: The most common cause of this that I've seen is that folks don't properly accrue their liabilities,... because it's tedious. Here's the thing though, going through the process, especially at first, helps you get your finger on the pulse of your business.
  • P&L vs cash flow forecasting: In addition to a monthly P&L, I also have a pretty robust desktop forecast model (which I won't go into, and probably wouldn't be useful to most people here), and a 12 week cash flow planner. Do this. It will help you keep track of the liabilities you have hanging out there without the hassle of GAAP accruals. You can leave that to your CPA at year end.
Here's how you build the sheet:
Starting cash balance +
Cash In (separate lines for AR/open orders/forecasted sales) -
Overhead expenses incl wages and insurance by line (actual AP + forecasted) -
Cogs expenses (actual AP + forecasted)-
Other expenses (actual AP + forecasted) =
Ending cash balance

That grid goes out at least 8 weeks. 12 is better.

Separate section below for random items where you know you'll be spending money but aren't sure exactly how much and when.
You need forecasts to predict cashflow. No business is 100% efficient. You'll get less or more sometimes, but at least you obtain a THEORETICAL reading based on the output of your equipment or staff.
A quick search shows that 'accrued liabilities are liabilities that reflect expenses on the income statement that have not been paid or logged under accounts payable during an accounting period,in other words, obligations for goods and services provided to a company for which invoices have not yet been received.' Which means that your actual cashflow (when people do pay up) falls short of projected targets. You don't get paid, and that's no cash, or a loss, to pay for business upkeep.

Other than that, accounting is just your present materials diminished by factors like decay or market devaluation, sales minus cost.
 

MidwestLandlord

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A quick search shows that 'accrued liabilities are liabilities that reflect expenses on the income statement that have not been paid or logged under accounts payable during an accounting period,in other words, obligations for goods and services provided to a company for which invoices have not yet been received.'
Yes.

For accrual based accounting only. This is a short term or long term liability (a balance sheet item) that the company OWES but has not yet been billed for. It's creating a transaction to record that the debt is owed (a claim on the company's assets), even though a formal record of that debt has not yet been received.

After the invoice has been paid, then the accrual is reversed and the actual invoice is transacted in the proper account as an expense (an income statement item)

The point of accrual based accounting is to keep the revenue and expenses generated by that revenue in the same accounting period.

In other words, you want the money made TODAY to be in the same period as your expenses made TODAY, regardless of when the expenses actually get paid.

Which means that your actual cashflow (when people do pay up) falls short of projected targets. You don't get paid, and that's no cash, or a loss, to pay for business upkeep.
No.

Accruals are LIABILITIES created and tracked TODAY, but PAYABLE in the FUTURE. They are not income or cash flow. (although of course they are used for projections of cash flow)
 

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No.

Accruals are LIABILITIES created and tracked TODAY, but PAYABLE in the FUTURE. They are not income or cash flow. (although of course they are used for projections of cash flow)
Oops.
Sorry....I was banking on the assumption that there might be customers who don't pay, leaving with unsettled gaps. Of course accruals will work when they pay up eventually.
Thanks.
I'm having to learn accounts on my own these days...I think we need some threads on this. I can't just hire CPAs blindly!
 

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Oops.
Sorry....I was banking on the assumption that there might be customers who don't pay, leaving with unsettled gaps. Of course accruals will work when they pay up eventually.
Thanks.
I'm having to learn accounts on my own these days...I think we need some threads on this. I can't just hire CPAs blindly!
I see. It's all good.

You're talking about accounts receivable. People that owe YOU money, and not having the cash to cover liabilities because of past due accounts not being paid.

That's how companies go bankrupt. Bankruptcy is not having the cash to cover liabilities, and has nothing to do with "profits"

Plenty of companies that are profitable go bankrupt because they have no cash.

In my unprofessional opinion (consult a qualified accounting professional for actual advice), most people starting out should use Cash Basis accounting, not accrual. Or, hire a CPA and be done with it.
 
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Profit First is a behavioral cash management system that uses the financials (prepared by an accountant or bookkeeper likely using GAAP) to assess the financial health of the business. GAAP is only crap when it comes to managing our money!

The cool part about Profit First is you can be proactive in preparation to grow your business without tapping into your profits by specifically allocation money to that initiative. It is so so common for entrepreneurs not to pay themselves. That is a dangerous game because it rids us of any motivation and to be completely honest who wants to run a business day in and out to pay taxes and your internet provider! I have watched Profit First save 100s of business and quite frankly with that lives because let's be real, our finances trickle into every aspect of our lives.

Cheers to a healthy business!
Pretty good summary!
 
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So I may have accidentally attracted several people to Fastlane Forum through this thread. When I google "does Profit First work?" This thread is on page 3 of google (figures, I can't even do that well with my own damn site haha)

While it's great that people are finding this and putting in their own two cents on the method, I don't want this thread to just be an advertisement for a book.
 

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So I may have accidentally attracted several people to Fastlane Forum through this thread. When I google "does Profit First work?" This thread is on page 3 of google (figures, I can't even do that well with my own damn site haha)

While it's great that people are finding this and putting in their own two cents on the method, I don't want this thread to just be an advertisement for a book.
MJ must have some kind of SEO magic magnet here....it's incredulous. This ain't the first time though, especially with the Tai Lopez scenerio (I even found that Alexa indexed it as a keyword to bring people to TFLF)

But it's fine. If Profit First can help, let it help more people. That's how value goes about. That's what I like about SEO, really cuts pass the limitations of ordinary word of mouth. But I think there's a hidden upsell in the book for Profit First accounting services....Mike's present venture.

Maybe if you linked with a high discussion facility like Disqus (similar to this forum where lots of people congregate to discuss matters), Google could find lots of interest around the topic or website to zero in. Websites with lots of comments, guest posts and reader input are usually on the first featured posts. It's all about reciprocality.
 

MJ DeMarco

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Profit First is a behavioral cash management system that uses the financials (prepared by an accountant or bookkeeper likely using GAAP) to assess the financial health of the business. GAAP is only crap when it comes to managing our money!
Can you please disclose your business relationship if you're going to comment like a bystander. Thank you.
 

brickco

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This concept may work if you have an extremely simple business, but I would argue that this mindset of profit entitlement is not a good one.

Let's say you import product to sell on Amazon. You order $500 of product and project that you will make $200 profit if they all sell so you put $200 to your profit account and spend it on other things. What if a new competitor forces you to lower your prices and you have more returns than expected? You either cough up the money or your customers that want returns are getting screwed.

It's nice to talk about expenses as if they are easily removed and flexible. Most of the time they're not, especially in small businesses. Most of the expenses are payroll and cost of goods. These things require cash-flow planning. If you decide you can't afford product or staff once your bank account hits $0, it's way too late and your entitlement is screwing someone else over when you can't pay.

You profit last. Wishful thinking doesn't change that.
 
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Can you please disclose your business relationship if you're going to comment like a bystander. Thank you.
Sorry MJ, looks like I attracted a few promoters.
 

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