PROFIT FIRST: OVERVIEW
BANK BALANCE ACCOUNTING
Most entrepreneurs don’t have the time or gumption to read the different accounting statements necessary to manage the fnancial aspect of their business.
Theoretically you should review and correlate your Income Statement, Balance Sheet and Cash Flow Statement monthly (or more frequently), but few entrepreneurs do. Most resort to “bank balance accounting,” where we check our bank balance every day and make fnancial decisions based upon what we see.
Per Parkinson’s Law, we consume what we see in our bank account. Proft First encourages the entrepreneur to continue “bank balance accounting” by frst allocating money to proft (and other accounts) so that the entrepreneur sees the actual portion of deposits that are available for expenses and they automatically adjust their spending accordingly.
THE PROFIT FIRST FORMULA
The GAAP (Generally Accepted Accounting Principles) formula for determining a business’s proft is Sales – Expenses = Proft. It is simple, logical and clear. Unfortunately, it’s a lie. The formula, while logically accurate, does not account for human behavior. In the GAAP formula proft is a left over, a fnal consideration, something that is hopefully a nice surprise at the end of the year. Alas, the proft is rarely there and the business continues on its check to check survival.
Sales – Expenses = ProftSales – Proft = Expenses
With Proft First you to fip the formula to Sales – Proft = Expenses. Logically the math is the same, but from the standpoint of the entrepreneur’s behavior it is radically different. With Proft First, you take a predetermined percentage of proft from every sale frst, and only the remainder is available for expenses.
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Author and historian C. Northcote Parkinson theorized that our demand for a resource increases to meet the supply of it. That is why when we are given two weeks to do a project it takes two weeks, and when we are given eight weeks to do the same project it takes eight weeks. That is why when given $1,000 to complete our work we get it done with $1,000 and when given $10,000 to complete the same work, it takes $10,000. Proft First makes Parkinson’s Law an asset. By taking proft frst the money available for expenses lessens, and we are forced to fnd ways to get the same things done for less money.
Many entrepreneurs try to force themselves to become better at accounting and to become more disciplined in their fscal management by pure willpower. But just like a muscle, willpower can be drained. And in a moment of fnancial stress or bigger than expected expenses the entrepreneur will break their own fscal rules and spend the money they have.
The Proft First principle does not try to change your habits (that is nearly impossible to do), Proft First works with your existing habits. By frst allocating money to different accounts, and then removing the temptation to “borrow” from yourself, your business will become fscally strong and you will beneft from regular proft distributions.