In the previous banking article we looked at the core accounts all business owners should use when first implementing Profit First in their Australian business. It’s time to start exploring some of the more detailed, advanced banking concepts that business owners may wish to explore. In this article we’re looking at the Drip Account and the type of businesses that could benefit from the technique.

The Drip Account

Not all Income received by certain businesses is payment for goods and services that has been delivered. Many businesses received prepaid income – payment for services that will be delivered in the future. If we were to transfer these amounts to our Profit First Core Accounts when it is received the cash would be spent long before we incur the expenses and even before we’ve technically ‘earned’ it.

To combat this issue, we use what’s known as a Drip Account. As the name suggests, our Drip Account ‘drip feeds’ cash to our Income Account once we’ve determined it’s really income. This ensures that the funds cannot be consumed by the business, in bulk, when we receive it.

Businesses that typically use Drip Accounts

Drip Accounts are not necessary for all businesses. A few examples of situation in which the Drip Account could be relevant are:

Businesses that receive prepaid income

If your customers pre-pay for your services a drip account can be a great tool. Tourism businesses, in particular, can benefit here. When customers book their holiday activities they will often pay months in advance as part of the preparation process. From their perspective this is intended to secure their place. From the business’ perspective this income hasn’t really been earned until the customer uses the service, especially if the amount is subject to a refund policy.

Businesses that offer upfront payment discounts

Many service businesses offer an up-front or bulk buy discount. If you run a yoga studio, for example, you may offer a bulk buy discount. Buy 12 weekly sessions and only pay for 10. By putting this income in the Drip Account we can recognised part of the income each week as the deal gradually expires.

Businesses that make purchases on behalf of a client as part of delivering their services

This type of situation is common in the design industries. Interior decorators and other fit-out businesses may receive a large amount of cash from their client up-front. Some of this amount will be a payment for their services. The balance will be for purchasing furniture and equipment that form part of the finished product. The Drip Account is a great way of ensuring that the funds for buying equipment is kept separate from your other income.

Businesses that sell gift cards

If your business sells a lot of gift cards you can keep this income separate until the card is used or it expires.

Getting funds into the Drip Account

In practice I’ve seen the money flow to the Drip Accounts in three different ways:

1. All income first flows through the Drip Account – This involves giving the Drip Account details to your customers as if it was your income account. When you sit down to do your Profit First transfers all income that is not Drip income is transferred to your normal income account.

2. Just Drip Income flows to the Drip Account – Here we give the BSB and Account number for our drip account to customers who are paying us an amount that needs to sit in the drip account. This method is problematic for businesses that offer electronic payment options, especially if all your income comes through a POS system.

3. You use your Income Account to fill the drip account – This is easily my preferred method. I use this method in my own business. All your Income first enters the business through the Income Account as usual. When you complete your Profit First transferred you send the Drip income to your Drip account first.

Getting funds out the Drip Account

The method used to track the drip account balance and work out how much to transfer to your Income Account depends on the type of income being received.

• If you work on large projects with varying timelines you’re best to use a spreadsheet to track how much income can be claimed from each project in a certain period. This sort of system works well for builders who take large deposits and/or progress bill;

• If you receive a large number of small drip amounts we recommend coming up with a logical percentage to use each period. For example, If you run the yoga studio mentioned earlier and you sell lots of 12 week, prepaid class cards then i’d transfer around 10% of your drip account to the Income Account each week.

The Drip Account and Tax

It is important to remember that Profit First is a Cash Flow system. Just because we have kept the amount separate in the Drip Account to help our cashflow doesn’t necessarily mean there are no tax obligations. You should work with your accountant or your Profit First Professional to determine whether or not the cash sitting in the drip account is subject to Income Tax or GST.

My Own Experience

I use a Drip Account in my business. Many of my twelve-month Accounting service packages, while billed on a monthly subscription basis, offer an upfront payment discount. When clients choose to take up this discount I allocate the payment to the Drip Account. Each month the Drip Account pays one month’s payment to my Income Account ready to do my normal Profit First transfers. The Account’s balance, and the required amount to transfer is all tracked in a spreadsheet.

A Quick Warning

I will include this brief warning/comment in each article regarding the use of accounts beyond the core five. It is very easy to over complicate the Profit First system by adding too many accounts. In fact, it is one of the most common reasons entrepreneurs fail to stick with the system. Please keep this in mind when considering whether the account(s) discussed in this article are right for your business.

Further Information

Read our comprehensive review of Profit First here.

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