The real 'profit first' accounting method

[Johnny boy]

Old model:

Sales-expenses = profit

"Profit first" model:

Sales - profit = expenses

I don't know about you, but I don't really pick my business expenses all that much. "Hey boss, why is my paycheck half as much?" "Oh, sorry Alex, after taking out 30% of revenue for owner's pay, the percentage leftover for your payroll was a lot less, tough luck bud".

"Profit first" would really look like this as an example.

1. I want 15k a month. (That means 15 X 1.2 since 20% is tax = 18k a month income)

2. For my lawn care company, I add up all of the costs per crew. Let's say after labor+payroll taxes, gas, equipment, vehicle payment, and a split of other costs like software and rent, it adds up to close to 9k.

3. To hit my 18k income, how much do I need to bring in per crew?

1 crew: 9k costs + 18k profit = 27k revenue needed with one crew. Likely not going to happen. That's a pretty aggressive number.

2: 9k costs each = 18k + 18k profit = 36k revenue needed / 2 = 18k revenue needed per crew. More manageable.

3: 27k + 18k = 45k / 3 = 15k revenue needed per crew.

4: 13,500 revenue needed per crew

5: 12,600 revenue needed per crew.

See how the difference levels off and it makes more sense to squeeze some profitability out of each crew instead of adding new ones only? The difference here is just $900 per month. It would literally only be an extra 22.5 minutes of work per day for each crew and our profit from 4 crews would be the same as with 5.

This determines your prices, the amount of work that goes on the schedule. That's how I would really organize my numbers with a "profit first" mentality. That's what it really looks like to put profit first. You pick the number, do some math, and it tells you what you need to be hitting.

We assign a "time value" to what a customer is paying.

When we estimate, we assume every minute of our time including driving is worth $4 a minute. If your yard takes 20 minutes and 5 minutes of driving, we will charge you 4x25 = $100/mo for every other week services.

If we need one crew to bring in 15k/mo, we divide 15k by $4/min and get 3,750 minutes worth of work. If services are biweekly, that's 10 working days, so 375 minutes of driving+working for each crew would equal our 15k/mo goal. That's less than 6.5 hours of work a day.

Then, we track time on jobs and determine how profitable customers are. If their visits take 45 minutes (including driving) for biweekly services they should be paying 180/mo. If they aren't we would raise prices or get rid of them. We can organize customers by their profitability rate based on average visit time and adjust accordingly.

Profit first for us looks like setting a number, figuring out our variable costs, and picking the revenue we'd need for each crew in order to hit the numbers. I would never put the expenses at the end of that equation. I don't get to wave a wand and decide we will only spend $100/mo on gas, or pay employees $12/hr and expect anyone to stay working here next month.

Then, AFTER you've done this, then go ahead and setup an automated withdrawal system to send percentages of income into other accounts, so you don't spend money you should be using for other things.

 

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[SparksCW]

Have you actually read the whole book or just the cover?

Profit first isn’t simply about deducting your profit first. It’s about making sure there is profit to be taken in the first place and managing the cash to ensure the profit is actually available to be taken.

Profit First has transformed my business and personal finances. Long way to go but the methodology is sound.

I agree with your breakdown also, that’s reverse engineering your company based on your goals which is essential.

 

[The Sandman]

That's less than 6.5 hours of work a day.

That's a full 8h day's work once you add in breaks and allowances.

 

[Johnny boy]

That's a full 8h day's work once you add in breaks and allowances.

The cool thing is that no, you're wrong.

 

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[Guest-5ty5s4]

How would you do this for large one-off projects of varying sizes without any recurring component?
Say you have a 1 million dollar construction project with $500,000 in labor and $300,000 in material and subcontracts, expect to make $200,000 after the fact but you also have utility bills, property mortgage/SBA loan, office staff salaries, etc.

How would you do "profit first" accounting for that type of biz?

(You would have more projects like that in the pipeline of course, working on finding more of them too)

 

[Kak]

Not a fan of the profit first crap. Just run your business. Be smart about expenses. Manage for cash flows.

I couldn’t get into it and found it a solution without a problem.

Ex: What if I just want my business to buy a balling “Platinum” truck instead of a work grade truck? Of course that increases my expenses and reduces my “profit.” But my company is mine and maybe it’s emotionally profitable to me to buy whatever the hell I want… That’s expense first. Lol.

 

[The Sandman]

The cool thing is that no, you're wrong.

Spoken like someone who defines "working" as being there. Most people have no idea how much non-productive time is normal.

 

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[The Sandman]

Not a fan of the profit first crap. Just run your business. Be smart about expenses. Manage for cash flows.

I couldn’t get into it and found it a solution without a problem.

It reminds me of the "pay yourself first" saving strategy.

 

[Kak]

It reminds me of the "pay yourself first" saving strategy.

Agreed. Something I have also had no use for.

It may help some people. To each their own. These books are just words to me. No paradigm shift. No great revelation.

 

[Guest-5ty5s4]

Not a fan of the profit first crap. Just run your business. Be smart about expenses. Manage for cash flows.

I couldn’t get into it and found it a solution without a problem.

Ex: What if I just want my business to buy a balling “Platinum” truck instead of a work grade truck? Of course that increases my expenses and reduces my “profit.” But my company is mine and maybe it’s emotionally profitable to me to buy whatever the hell I want… That’s expense first. Lol.

True. The platinum grade truck would still fall under "unusuals" or SDE on your accounting anyway.

In fact, you'd definitely keep that value once you spent it - because it's already spent... Lol... It just depends on what the goal is I guess.

The benefit of having real profits would be funding growth.

 

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[Johnny boy]

How would you do this for large one-off projects of varying sizes without any recurring component?
Say you have a 1 million dollar construction project with $500,000 in labor and $300,000 in material and subcontracts, expect to make $200,000 after the fact but you also have utility bills, property mortgage/SBA loan, office staff salaries, etc.

How would you do "profit first" accounting for that type of biz?

(You would have more projects like that in the pipeline of course, working on finding more of them too)

Every job is different right? The numbers change so your business model actually changes slightly each time. Nothing is ever the same.

But, you can average things out and use that to help with the basic math that will get you towards your goals.

You want to make 300k a year?

That's 300k from one project, 150k from 2, or 100k from 3.

How many can you do in a year? Can you change that number? What limitations exist on that number?

If you can count on only doing 1 a year, you'll need to make 300k from that one.

Add up everything you'll expect to spend INCLUDING office workers, etc. You don't pay them in monopoly money, it all still counts.

Your bid amount for the project is now this formula. (total cost + 300k)

If you can do two of these in a year then it's (total cost + 150k) for each project.

If that "+" part makes the bid price way way too high to ever be accepted, then you HAVE to do more projects or change your goals.

Super basic math. But your frame is f*cked up. It's not a million dollar contract. It's up to you to decide what you'll charge for it. Add up the costs and add in your profit. Work backwards and the price you charge is at the end of that equation.

 

[Guest-5ty5s4]

Every job is different right? The numbers change so your business model actually changes slightly each time. Nothing is ever the same.

But, you can average things out and use that to help with the basic math that will get you towards your goals.

You want to make 300k a year?

That's 300k from one project, 150k from 2, or 100k from 3.

How many can you do in a year? Can you change that number? What limitations exist on that number?

If you can count on only doing 1 a year, you'll need to make 300k from that one.

Add up everything you'll expect to spend INCLUDING office workers, etc. You don't pay them in monopoly money, it all still counts.

Your bid amount for the project is now this formula. (total cost + 300k)

If you can do two of these in a year then it's (total cost + 150k) for each project.

If that "+" part makes the bid price way way too high to ever be accepted, then you HAVE to do more projects or change your goals.

Super basic math. But your frame is f*cked up. It's not a million dollar contract. It's up to you to decide what you'll charge for it. Add up the costs and add in your profit. Work backwards and the price you charge is at the end of that equation.

Very good. Yeah this makes perfect sense and is basically how we already do it (I'm still learning - this seems to be how *they* do it, not me)

I definitely see what you're saying

 

[Johnny boy]

Very good. Yeah this makes perfect sense and is basically how we already do it (I'm still learning - this seems to be how *they* do it, not me)

I definitely see what you're saying

I just sent out a bid for a much smaller 50k project today and did the same thing. I ran my numbers, added in a healthy profit and submitted the bid. We’ll see if it’s accepted

 

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[John Clancy]

Not a fan of the profit first crap. Just run your business. Be smart about expenses. Manage for cash flows.

I couldn’t get into it and found it a solution without a problem.

Ex: What if I just want my business to buy a balling “Platinum” truck instead of a work grade truck? Of course that increases my expenses and reduces my “profit.” But my company is mine and maybe it’s emotionally profitable to me to buy whatever the hell I want… That’s expense first. Lol.

To be fair - if you're the type of person who can run their business profitably with little more than the maxims of "be smart about expenses" and "manage for cash flows", you're probably not the target demographic.

The narrative of the book hints that the intended audience is agencies, service businesses and scrappy startups that need to mind their money - avatars who might need an extra leg up when it comes to managing their finances.

As another poster here pointed out, the rationale behind the book is very similar to "pay yourself first". I.e. if you're someone who tends to eat everything that's on your plate, the easiest way to manage how much you eat is to buy smaller plates - or put less on them in the first place. In FLF parlance, it's the defense to your business's offense.

If you're already savvy enough to take care of things without needing a framework like Profit First to guide you, then you're not going to find much benefit in it. And yes: there's more to running a business than actuarial analysis of every single outflow (like your Platinum truck). Sometimes, purchases that don't make sense "economically" are an absolute no-brainer from a signaling, psychological, or emotional perspective.

But IMO, for the average business owner who's barely breaking even and pretty much starting from scratch each month, there's value in the discipline.

Budgets, forecasts, meticulous expense tracking, Profit First accounting - they're all just tools. No tool is universally useful, but everything has its place.

 

[The Sandman]

To be fair - if you're the type of person who can run their business profitably with little more than the maxims of "be smart about expenses" and "manage for cash flows", you're probably not the target demographic.

The narrative of the book hints that the intended audience is agencies, service businesses and scrappy startups that need to mind their money - avatars who might need an extra leg up when it comes to managing their finances.

As another poster here pointed out, the rationale behind the book is very similar to "pay yourself first". I.e. if you're someone who tends to eat everything that's on your plate, the easiest way to manage how much you eat is to buy smaller plates - or put less on them in the first place. In FLF parlance, it's the defense to your business's offense.

If you're already savvy enough to take care of things without needing a framework like Profit First to guide you, then you're not going to find much benefit in it. And yes: there's more to running a business than actuarial analysis of every single outflow (like your Platinum truck). Sometimes, purchases that don't make sense "economically" are an absolute no-brainer from a signaling, psychological, or emotional perspective.

But IMO, for the average business owner who's barely breaking even and pretty much starting from scratch each month, there's value in the discipline.

Budgets, forecasts, meticulous expense tracking, Profit First accounting - they're all just tools. No tool is universally useful, but everything has its place.

Spot on. I'm with Kak in that it seems painfully obvious that the point of a for-profit business is to make Profit. But I'm regularly reminded that not everyone recognizes this.

In large organizations this tends to get lost by people having different goals/metrics. Sales departments tend to focus on More Sales. While this means more revenue this doesn't necessarily mean more profit. They need to be kept in check with someone watching the bottom line.

Lately I've been searching for businesses to buy. Found a local listing for a 14-year old cleaning business touting revenues of +500k/year, excellent reviews, loyal customers and a waiting list of new customers. But the guy works as the office manager and makes a profit of 40k, and he's asking 375k! Who would spend that kind of money just to get an office manager job at average pay?? He seems to have no concept that a business is supposed to make money, and if it doesn't do that it isn't worth much.

It's a shame because that business could be turned into something nice by raising rates but his price is insane. I'd buy it for 40k.