The Profit First book focuses on improving business profitability. You set-up your small plates, cut expenses and finally start to see some reward for all your efforts. Recently, I started working with a new client who really doesn’t have this problem. Don’t get me wrong, his business struggles to pay its bills and never has cash to pay the ATO, but business expenses are not the problem. The business is profitable, the business owner just spends too much of it! That was clear 30 seconds after I opened his Xero file. After the somewhat uncomfortable conversation that followed I thought I’d quickly touch on the concept of living Profit First.
Sometimes the Cashflow problem is you!
I’ve been working with small and medium sized businesses for about 10 years now. You’ve all heard the stats about small business failures and the constant cashflow battle. That’s usually when Accountants start talking about concepts like Debtor and Creditor Days, Inventory management techniques and other working capital management topic.
While those are certainly important you wouldn’t believe the number of times the problem has nothing to do with the business at all. The customers pay on time, the creditors give more than generous payment terms and, overall, the business is profitable.
The problem, as hard as it may be to accept, is the owner. If they spend $75 out of every $100 that comes in the door on personal expenses no amount of business coaching or accounting advice can dig them out of that hole.
This is particularly an issue for start-up businesses where the owner has personal bills to pay but the business hasn’t established a solid monthly income yet.
Living Profit First
Very early in my business I was concerned that I wasn’t building wealth. The business was making money and I was taking my salary but now that I was self-employed I wasn’t getting superannuation contributions (for example). As my salary grew so did my expenses and I still had nothing left. Parkinson’s Law all over again!
To prevent myself from starving my business of working capital, control my personal expenses and avoid my lifestyle consuming the funds that should have been building wealth for my family I implemented the following:
Opened a personal Income Account:
This works exactly the same as my business Income Account. Each fortnight the business pays a fixed salary into this account and I budget from this amount like I would if I was an employee.
Opened Four (4) Money Management Accounts:
50% of my fortnightly salary goes into my living expenses account. A lot of cuts were made to my personal expenses to be able to bring the number down that low!
25% of my fortnightly salary goes into my Grow Account. This is my investment money. If, after I do my tax planning calculations, I decide to make a super contribution I get the money from this account.
20% of my fortnightly salary goes into my Blow Account. This is pretty self-explanatory. It’s the money I’m allowed to have fun with. Entertainment, presents for my family (or a new Xbox for dad). I allow myself to spend this without feeling guilty!
5% of my fortnightly salary goes into my Emergency Account – just in case! With a young family and a small business, you never know when something is going to come up.
The Barefoot Investor
While my personal focus is on business finance and tax issues Scott Pape and his book The Barefoot Investor takes the Envelope cash management system and applies it to your personal finances.
If you’re interested in another perspective on this type of financial management system I’d certainly recommend the book. I’ve heard mixed reviews on the paid ‘Blueprint’ service offering. However, the book itself is full of useful information.
Read our comprehensive review of Profit First here
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