Every single entrepreneur is (or should be) familiar with GAAP—the generally accepted accounting principles most companies uses to compile their financial statements. These procedures not only govern the way we report what’s going on in our companies, but they also end up shaping the way we think about our companies.
Most of us look at the revenue at the top of our income statement, subtract our expenses, subtract our salary, and see what’s left—way down at the bottom of the page—as our profit. And often, by the time we get all the bills paid, there’s barely anything left in the profit category. But that’s just the way business goes, right?
Wrong!
Status Quo
Think about it for a minute: It’s simply human nature to spend every bit of our resources. When you were in college, eating ramen noodles and counting out your beer money until your next payday or that monthly check from your parents, you would have considered your current salary to be an absolute fortune. How do you feel about that salary now? It doesn’t go nearly as far as you thought it would, does it?
The fact of the matter is, we spend what we make. And when we make more, we spend more.
I learned long ago that the surest way to burn out is to fight against human nature. It’s much more rewarding—and a whole lot easier—to find a way to work with human nature.
Thinking Outside the Box
I’ve developed a method of accounting I call Profit First that ensures that you take care of what’s important before addressing all the other, ultimately less important needs of your business. This accounting method is effective because it’s simple and based on absolutely sound principles.
Here’s how it works: You start with revenue, and before you pay yourself, before you pay a single bill, you allocate a percentage of that revenue to your profit. Once the profit’s accounted for, you pay your salary, then you take care of your expenses.
You may think this is some silly little trick. After all, the bottom line has to be the same, right?
Absolutely not. Because once you’ve set aside your profit, the balance of your revenue is all you have to work with. And rather than cheating your company out of its reason for being—the profit—you’ll be forced to find ways to get your expenses to a manageable level while still maintaining a healthy level of investment in your company’s future. Profit First shifts your attention to what’s really important.
The thing is, you didn’t start your company so you could pay bills, right? Nope. You started your company because you had a vision that you believed could be profitable. When it comes to your business, the Profit First method of accounting makes much more sense than GAAP does.
One of the most important things you'll need to figure out before implementing Profit First is what percentage of your revenue you should commit to counting as your profit. I recommend looking at the big, successful, public companies in your industry and taking your cue from those healthy businesses. Whether their profit is 5 percent or 15 percent, you’ll be able to look at the financial statements of those public companies and use that percentage to guide your decision. Once you know that percentage, your profit should be designated for an interest-bearing account. Without fail, this interest-bearing account should get its share before you allocate money anywhere else.
How do I know Profit First works? I’ve successfully used it in my business for years, and I’ve helped my clients implement it in their companies as well. The results are inevitable: healthy, interest-earning accounts with funds that would otherwise have been frittered away on petty expenses. Profit First pushes you to be frugal and rewards you at the end of the year with a profitable, healthy company—one that has the capital to grow even further.
Look for my next book, Profit First: A Simple System to Transform Your Business From a Cash-Eating Monster to a Money-Making Machine, in the summer of 2014, or attend my teleconference about it during the week of March 17-24.
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