⬅️ Hub: Self-Improvement

Description

Mike Michalowicz argues that most small businesses stay unprofitable because owners follow the accounting formula Sales − Expenses = Profit, which leaves profit as whatever is left over, and there rarely is anything left. He flips it to Sales − Profit = Expenses: every deposit is split by fixed percentages into separate bank accounts for Profit, Owner’s Comp, Tax, and Operating Expenses, so the business must run on what remains. Drawing on behavioral research about portion sizes, he builds the system on four principles (small plates, serve sequentially, remove temptation, enforce a rhythm) and turns them into a concrete routine: an Instant Assessment of the business’s health, Target and Current Allocation Percentages raised a little each quarter, allocations on the tenth and twenty-fifth of every month, and quarterly profit distributions to the owner. Later chapters cover paying down debt, finding efficiency instead of chasing sales, advanced account setups, applying the system to personal finances, and the behavioral mistakes that make it fail.

Vault PDF and source boundary

Open the complete book (file not included in this release) (revised and expanded edition)

Navigation note: page links use the PDF viewer’s page count, not the printed pagination. Figure 4 (Target Allocation Percentages) was transcribed from the book’s image.

Evidence boundary: these notes reconstruct the author’s system and argument from the supplied book. Client stories and results are the author’s; most are anecdotal and have not been independently checked. Tax guidance reflects the author’s general advice, not advice for any specific business.

Chapter-by-Chapter Overview

Linked reading map

Use the entries below to jump to the full argument, analytical divisions, essential evidence, concepts, conclusion, and reflection questions for each part of the book.

• Introduction: Michalowicz argues that chronic unprofitability stems from the Sales − Expenses = Profit formula and not from the owner, and proposes taking profit first, a system he says works with entrepreneurs’ habits and demands action, not just reading. PDF p. 14 (file not included in this release)
• 1. Your Business Is an Out-of-Control Cash-Eating Monster: Michalowicz diagnoses why businesses become cash-eating monsters: owners manage by bank balance, fall into a Survival Trap, and follow accounting that puts sales first and leaves profit as a leftover. Profit First is offered as a human-scale fix. PDF p. 24 (file not included in this release)
• 2. The Core Principles of Profit First: Drawing on a diet program and behavioral science, Michalowicz derives four principles (small plates, serve sequentially, remove temptation, enforce a rhythm), restates them as Sales − Profit = Expenses with allocation accounts, and starts readers with a 1 percent transfer. PDF p. 48 (file not included in this release)
• 3. Setting Up Profit First for Your Business: Modeled on his mother’s envelope system, the chapter sets up Profit First in the bank: five foundational checking accounts at a primary bank and two inconvenient savings accounts at a second bank, so balances stay meaningful and tempting money stays out of reach. PDF p. 64 (file not included in this release)
• 4. Assessing the Health of Your Business: The chapter teaches the cash-based Instant Assessment: compute Real Revenue, sort actual spending into Profit, Owner’s Comp, Tax and Operating Expenses, compare with target percentages, and read the Delta and Fix, accepting the painful gap as the starting point. PDF p. 74 (file not included in this release)
• 5. Allocation Percentages: Michalowicz sets Target Allocation Percentages for Profit, Owner’s Comp and Tax from industry and personal data, then has owners start at their Current Allocation Percentages and raise them gradually, avoiding both paralysis and overreach. PDF p. 92 (file not included in this release)
• 6. Putting Profit First into Motion: Michalowicz gives the step-by-step implementation: set small starting percentages, allocate every deposit through the INCOME account, cut expenses, run the tenth and twenty-fifth rhythm, and take a quarterly profit distribution while raising percentages toward the targets. PDF p. 107 (file not included in this release)
• 7. Destroy Your Debt: Debt cannot be cured by crash-diet panic. Michalowicz says to start Profit First now, run a Debt Freeze that cuts operating expenses to 10 percent below target, send 99 percent of profit to debt, and sustain the habit by enjoying saving. PDF p. 132 (file not included in this release)
• 8. Find Money within Your Business: Michalowicz argues that profit comes from efficiency beneath the surface, not more sales: ask for two times the results with half the effort, expect competitors to squeeze margins, and fire bad clients, clone the best, and sell smart. PDF p. 151 (file not included in this release)
• 9. Profit First—Advanced Techniques: After two full quarters of core practice, owners customize Profit First by adding purpose-specific accounts, documenting the process, replacing the monthly nut with a Required Income for Allocation, and using ratios and behavioral tactics to guard cash. PDF p. 166 (file not included in this release)
• 10. The Profit First Life: Michalowicz carries the system into personal finance: freeze debt, set up personal small-plate accounts, cut expenses decisively, split distributions between debt and reward, lock the lifestyle against Parkinson’s Law, and teach children with envelopes. PDF p. 182 (file not included in this release)
• 11. How to Keep It from Falling Apart: Profit First fails mainly through owner behavior; Michalowicz names eight mistakes, starting with going it alone, and prescribes accountability, slow percentage increases, leaving allocations and the tax account untouched, and keeping the system in the bank accounts. PDF p. 197 (file not included in this release)
• Epilogue: Profit First is the granny shot of money management: an awkward-looking but more consistent method, built as a simple system that works with human habits, so owners should ignore skeptics and put profit first. PDF p. 210 (file not included in this release)
• Appendix 1: The Profit First Quick Setup Guide: A checklist of the one-time setup of two banks and seven accounts, then daily, tenth-and-twenty-fifth, quarterly and yearly actions, starting with current allocation percentages and moving toward targets. PDF p. 216 (file not included in this release)

Review

Handwrite First

Use this section with the book and notes closed. Retrieval matters more than polished prose.

1. Before Reading

• Prediction:
• Question I want answered:
• How I currently handle business or personal cash:
• What I expect to disagree with:

2. Closed-Book Recall Dump

• Main claims I remember:

• The accounts and what each is for:

• The routine (daily, tenth and twenty-fifth, quarterly, yearly):

• What feels fuzzy or incomplete:

3. Core Argument From Memory

• The book in one sentence:
• Why the traditional formula fails:

• The causal chain:
• Best evidence or story I remember:
• Most important qualification:

4. Feynman Check

Explain the system to an intelligent small-business owner who believes profit will come once sales grow. Circle any term—Sales − Profit = Expenses, Parkinson’s Law, the four principles (small plates, serve sequentially, remove temptation, enforce a rhythm), Real Revenue, the Instant Assessment, Target versus Current Allocation Percentages, PROFIT HOLD and TAX HOLD, the tenth and twenty-fifth rhythm, the quarterly distribution, the Debt Freeze, or Required Income for Allocation—that you cannot define without looking.

5. Pushback From Memory

• Strongest alternative explanation for unprofitability:
• Claim the author may overstate:
• Evidence that would change my mind:
• Where the system might not fit (industry, size, cash cycle):

Type Into Obsidian

After checking the chapter notes, correct the handwritten reconstruction.

1. Correction After Checking

• What I remembered accurately:
• What I distorted or omitted:
• Chapter or passage that corrected me:

2. Clean Core Argument

• Thesis:
• Reasoning:
• Essential procedure:
• Qualification:
• How I would apply it:

3. Connections

• The Toilet Paper Entrepreneur — the author’s earlier book on bootstrapping; how does its frugality anticipate Profit First?
• The Psychology of Money — Housel’s case for a high savings rate and room for error is the personal-finance version of taking profit first.
• Main Street Millionaire — would a buyer of a small business use the Instant Assessment as part of due diligence?
• Business MOC — where the allocation system sits beside the vault’s other business notes.
• New connection:

4. Flashcards / Atomic Recall

• Q: What formula does Profit First replace, and with what? A: Sales − Expenses = Profit becomes Sales − Profit = Expenses: profit is taken first and the business runs on what remains.
• Q: What are the four principles behind the system? A: Use small plates (separate accounts), serve sequentially (allocate before spending), remove temptation (move profit and tax money out of easy reach), and enforce a rhythm (allocate on a fixed schedule).
• Q: Which five accounts sit at the primary bank, and which two at the second bank? A: Income, Profit, Owner’s Comp, Tax, and OPEX at the primary bank; PROFIT HOLD and TAX HOLD at the second bank.
• Q: What is the difference between Target and Current Allocation Percentages? A: TAPs are where the business is heading; CAPs are where it starts today. You raise the CAPs in small steps each quarter toward the TAPs.
• Q: What happens on the tenth and twenty-fifth? A: Deposits in the Income account are allocated to the other accounts by percentage, and bills are paid from OPEX on those two fixed dates.
• Q: What happens to the Profit account each quarter? A: Half of it is distributed to the owners as a reward, and the rest stays as a reserve.

Retention Check

24 Hours Later

• Reconstruct the account structure and the routine from memory.
• Name one claim, one client story, and one warning from the book.

1 Week Later

• Run the Instant Assessment on a real business or on your household finances, noting which numbers are known and which are estimated.
• Explain why the author tells owners to start with a 1 percent profit allocation instead of the target.

1 Month Later

• Rebuild the system from “the formula is the problem” to “how to keep it from falling apart” without opening the note.
• Identify the part you would adopt first, the part you doubt, and the evidence you would need.

Notes

Book Argument and Reading Map

Michalowicz’s governing claim is that unprofitability is a design problem, not a character flaw. Owners are not failing because they are lazy or bad at business; they are following a formula, Sales − Expenses = Profit, that works against human nature. Because people spend what is in front of them, expenses grow to consume whatever revenue arrives, and profit becomes an afterthought that rarely materializes. The fix is to change the order of operations so the behavior takes care of itself.

The first part diagnoses and designs. Chapter 1 describes the “cash-eating monster”: owners who manage by glancing at the bank balance, stay trapped chasing the next sale to cover last month’s bills, and treat profit as a leftover. Chapter 2 borrows from research on portion sizes to derive four principles and restates the formula as Sales − Profit = Expenses, with the first small profit transfer. Chapter 3 turns the principles into a bank structure modeled on his mother’s envelope system: five accounts at a primary bank and two “no-temptation” accounts at a second bank.

The second part makes the system operational. The Instant Assessment measures Real Revenue and compares actual spending with target percentages for Profit, Owner’s Comp, Tax, and Operating Expenses (Chapter 4). Target Allocation Percentages are set from research, but owners start from where they are and move slowly (Chapter 5). The routine follows: allocate every deposit, cut expenses, run the books on the tenth and twenty-fifth, and take a quarterly profit distribution (Chapter 6).

The third part extends and protects it. Debt is attacked with a Debt Freeze and by sending most profit to repayment (Chapter 7). Profit is found through efficiency, firing bad clients, and cloning the best ones, rather than more sales (Chapter 8). Advanced techniques add purpose-specific accounts and better cash planning (Chapter 9). The same method is applied to personal finance (Chapter 10), and the common mistakes that cause the system to fail are named (Chapter 11). The epilogue’s “granny shot” image sums up the attitude: an awkward-looking method that works more consistently.

Michalowicz’s central sequence

People spend what they see → the traditional formula leaves no profit → separate accounts and fixed percentages change what they see → profit is taken first in small, rising steps → a twice-monthly rhythm and quarterly rewards make the habit stick → the business is forced to become efficient.

Interpretive guardrails

• The evidence is mostly the author’s client stories and his own experience; the behavioral research he cites supports the principle of small plates, not the specific percentages.
• The target percentages are typical ranges he has observed, presented as a starting point, not a standard for every industry.
• Tax and accounting practices vary by country and business type; the author tells readers to work with an accountant.

Introduction

Open in PDF — p. 14 (file not included in this release)

Chapter Objective and Through Line

Michalowicz opens with a scene rather than an argument: Debbie Horovitch, ten years into her social media agency, runs the Instant Assessment at a CreativeLive event and breaks down, repeating “I am a fool.” Her business had absorbed a decade of work and left her with no money to show for it. The introduction uses her reaction to name the book’s target, which is the owner who works harder and harder inside a business that is quietly failing, and who covers the truth with effort.

His central claim is that the failure lies in the formula and not in the owner. The conventional equation, Sales − Expenses = Profit, “makes mathematical sense” but not “human sense,” because “there are never any leftovers.” He compares trusting it to flapping your arms to fly: a few people survive, and we point at them as proof. The fix he proposes is one line, “Take your profit first,” and he insists it works with how entrepreneurs already behave: “You don’t need to be fixed. The system does.”

The rest of the introduction is persuasion and a demand for action. He supplies evidence that the system has worked (Keith Fear, his own newest company, practitioner counts), admits that changing is hard, and tells the reader to do the end-of-chapter action steps and not just read. It sets the book’s promise and tone, and Chapter 1 supplies the diagnosis.

Chapter Structure at a Glance

1. A single emotional case frames the problem: Debbie’s breakdown over the Instant Assessment shows that denial, covered by hard work, is what keeps unprofitable owners stuck.
2. Unprofitability is the norm, not the exception: most small businesses are barely surviving, and lack of profitability is the leading cause of failure, so the problem is systemic.
3. The system, not the owner, is at fault: the Sales − Expenses = Profit formula is the cliff-and-arm-flapping advice; the answer is to reverse it and take profit first.
4. Proof arrives through results: Keith Fear’s turnaround, the author’s own record, and the numbers of professionals and adopters suggest the system is repeatable.
5. Change is the real obstacle: the reader must stop doing what is not working, and must act on the steps rather than only read.
6. The revised edition keeps the core: the system is “foundationally identical,” with added shortcuts, stories and techniques.

Section-by-Section Argument

The introduction has no internal headings in the source, so the subsections below are analytical divisions.

Debbie Horovitch and the problem of denial (analytical division)

The opening story establishes why the book exists. Debbie had worked ten years and sacrificed her personal life, and the Instant Assessment showed how far her numbers sat from where they should be. Michalowicz’s point is that hard work is an easy way to cover an unhealthy business, because we assume that if we “can just hold out” something big will arrive. He had the same experience when he first designed Profit First to fix his own finances.

• He reframes her reaction: “Fools never seek out answers.” Facing the numbers is evidence of courage, and she asked him to print her name in the book.
• He traces the system’s spread: a paragraph in The Toilet Paper Entrepreneur, a Wall Street Journal piece, then emails from entrepreneurs, until he concluded that a full book was warranted. p. 16 (file not included in this release)

Why so many businesses are unprofitable (analytical division)

Here the story becomes a claim about scale. He cites the SBA figure of 28 million U.S. small businesses (125 million globally) and says that “eight out of ten businesses fail, and the number one reason they fail is lack of profitability,” quoting a Babson College report. p. 17 (file not included in this release) Appearance is a poor guide to health: the neighbor with the Tesla and a $3 million company is “one bad month from declaring bankruptcy,” and the networking-event owner who says business is great has not paid herself in nearly a year.

• His own history is the main exhibit. He was the celebrated young entrepreneur “taking out bank loan after bank loan” to cover payroll, and he used growth to hide that the business “had never once posted a profit.”
• He concludes that he was not the problem. He asks, “What if the system I have been told to follow is flawed?” p. 18 (file not included in this release)

The flawed formula and the one-line fix (analytical division)

This is the introduction’s core. Traditional accounting tells the owner to sell as much as possible, pay the bills, and treat what remains as profit. Michalowicz argues that this “creates monsters of businesses. Cash-eating monsters,” and that the real answer is to reverse the order: “Take your profit first.” He warns that the change will “challenge you” because it means abandoning a familiar habit, and he compares it to swearing off drinking after a hangover and not keeping the promise. p. 19 (file not included in this release)

• The arm-flapping analogy carries the logic: survivors of the old method do not validate it, because “Millions die and a few survive.”
• The mechanics are held back until later chapters; here he promises only that the idea is “profoundly simple.”

Evidence of results and the call to act (analytical division)

Michalowicz offers social proof. Keith Fear, who runs a hot-air balloon business and had passed a million in revenue while still holding a full-time job, read the book and “did nothing” for months. After he implemented it, his letter reports net profit up 1,721 percent year over year at one point in early 2015, up 335.3 percent for 2015 as a whole, and a net profit of about 22 percent. p. 21 (file not included in this release)

• The author says his company Profit First Professionals, run on the system from day one with “five foundational Profit First accounts,” is his most profitable ever, with profits “1,000 percent bigger” than his best prior year.
• 128 Profit First Professionals have guided about 1,280 businesses. His high-end estimate of adopters is “more than thirty thousand companies,” against 125 million businesses worldwide, so “we are not even at the starting line.”
• His request is behavioral: study it and do it. “Don’t skip the doing.” p. 22 (file not included in this release)

The adopter count is an estimate drawn from about five emails a day, on the assumption that many readers act silently.

Key Concepts and Distinctions

• Take your profit first: Reverse the traditional order so profit is set aside from each deposit before expenses are paid.
• Significance: It is the book’s whole proposal, stated here in its simplest form.
• The old formula (Sales − Expenses = Profit): The conventional accounting equation that leaves profit as whatever remains.
• Significance: Michalowicz blames it, not the owner, for chronic unprofitability, and everything later is built as its replacement.
• The Instant Assessment: A quick check of the business’s real financial health, which Chapter 4 teaches.
• Significance: It turns denial into a measured gap and is the entry point for the system.

Chapter Conclusion and Significance

The introduction concludes that permanent profitability is available to any owner who changes the structure of the money instead of trying to fix themselves. Debbie shows the emotional cost of the old way, the failure statistics show it is common, and Keith and the author’s companies show an alternative. Its promise is immediate: “Your profit will start today and will occur permanently,” beginning “with your very next deposit.”

The evidence here is testimonial and self-reported, and the reader is asked to accept it mostly on trust until the mechanics arrive. Several figures are the author’s estimates, and Keith’s percentages come from a letter, not an audit. The revised edition keeps a core that is “foundationally identical” to the first.

Questions for Reflection

1. Michalowicz says the owner does not need fixing and the system does. What does that claim change about how you would respond to an unprofitable business, and what might it overlook about owner behavior?
2. The arm-flapping analogy dismisses successful users of traditional accounting as lucky survivors. Is that a fair account of survivorship, and what evidence would test it?
3. Most of the proof offered here is testimonial. Which of the introduction’s claims would you want independently checked before committing to the system?

Chapter 1: Your Business Is an Out-of-Control Cash-Eating Monster

Open in PDF — p. 24 (file not included in this release)

Chapter Objective and Through Line

Michalowicz argues that most entrepreneurs, himself included, build businesses that turn into “cash-eating” monsters, and that the cause is how they manage money and not how hard they work. Using Mary Shelley’s Frankenstein as a running image, he says the creator’s miracle becomes a source of torment once revenue is chased without any structure for keeping cash. The chapter is his diagnosis: before the Profit First method is explained, the reader has to see why the usual approach fails.

The diagnosis has three layers. The first is personal: after selling two companies he squandered his windfall, hit a low point on Valentine’s Day 2008, and was rescued emotionally by his daughter’s piggy bank. The second is behavioral: owners run on “bank balance accounting” and fall into a “Survival Trap” of reactive selling. The third is structural: traditional accounting, built on Sales − Expenses = Profit, trains attention on revenue and treats profit as a leftover.

The chapter closes by proposing a remedy in outline. Profit First is a system “designed for humans, not Spock,” built on the habit owners already have of looking at their bank accounts. It sits in front of accounting and does not replace it. The later chapters supply the mechanics.

Chapter Structure at a Glance

1. A personal collapse establishes the stakes: a $388,000 windfall, reckless spending and investing, and near-total loss show that making money (income) and taking money (profit) are different things.
2. Money problems have two triggers: slowing sales expose a check-to-check business, and accelerating sales raise expenses until a drought arrives.
3. Growth is only half the equation: chasing size defers profit indefinitely, so profit must be a habit and not an event.
4. Owners manage by bank balance and fall into the Survival Trap: reactive selling relieves each crisis while pulling the business away from its vision.
5. Traditional accounting reinforces the trap: its formula puts sales first, hides profit from view, and defines profit as a paper number instead of cash.
6. Profit First is offered as the human-scale fix: it works with existing habits and leads to the call to commit.

Section-by-Section Argument

The Piggy Bank That Changed My Life (author’s heading)

The author’s personal story supplies the chapter’s moral. After receiving the first of several checks totaling the sale of his second company, he bought three cars and moved into expensive habits, then invested in about a dozen start-ups on the belief that his “golden touch” would carry them. Within twelve months all but one had failed, and “I was not an angel investor; I was the Angel of Death.” p. 27 (file not included in this release) By February 14, 2008 he was down to his last $10,000, and his accountant called with a $28,000 tax bill and a $2,000 fee.

• That evening his nine-year-old daughter Adayla returned to the table with her taped-up piggy bank and said, “Daddy, we’re going to make it.” He reads this as the essence of financial security: “save your money and block access to it so it doesn’t get stolen—by you.” p. 29 (file not included in this release)
• The scene links to the Instant Assessment, which can feel like a bucket of ice water, and he argues that facing the pain is better than operating in denial.

Money Problems (author’s heading)

Here Michalowicz generalizes from his own case. He had mastered growth but never profitability: “I had learned how to collect money, for sure, but I had never learned how to keep it, how to control it or how to grow it.” Money trouble, he says, occurs when sales slow down or when sales speed up.

• Slowing sales are the obvious problem: the check-to-check business loses its one big client and cannot cover expenses.
• Accelerating sales are the insidious one. A great quarter looks like a permanent upswing, spending locks in at the new level, and cutting back becomes nearly impossible because of the agreements and promises made, so owners “steal from Peter to pay Paul.”
• Without an understanding of profitability, “every business, no matter how big… is a house of cards.” p. 31 (file not included in this release)

Bigger Is Not Better (author’s heading)

This section attacks growth as the default definition of success. Owners keep hoping the next big sale or investor will finally produce profit, but “it never does,” like the carrot dangled before a donkey. The section’s central claim: “Profit is not an event. Profit is a habit.” It cites “Revenue is vanity, profit is sanity, and cash is king” as the reminder that the job is to maximize profit at whatever size.

• At a talk in Georgetown, Colorado, an attendee said she must reinvest to grow. Repeated “why” questions led her to admit she wants growth in order to make more money, which prompts his reply: “Why not just make more money now?”
• Jason Fried’s pizza chain, which scaled from twenty to forty locations and collapsed under debt, illustrates growth outrunning health. Fried’s phrase, “the right size will find you,” is the author’s claim that taking profit first reveals the appropriate size.
• The remedy is to “reverse engineer the profit”: fix profit first, then grow. p. 34 (file not included in this release)

Check-to-Check and Panic-to-Panic (author’s heading)

This section names the behavior behind the problem. Owners practice “bank balance accounting”: they log in daily, feel flush at a high balance and pay every pending bill, then panic when the balance drops and hurry to sell and collect. New revenue brings new expenses, so the cycle restarts, and the eventual “solution” is debt. The author argues that this is human nature and would take years to change, so the answer must be “a method that works with our nature, not against it.” Without one, owners fall into the Survival Trap. p. 36 (file not included in this release)

The Survival Trap (author’s heading)

His lawn-care contractor Ernie, who sells gutter cleaning, then roofing, then chimney repair to a captive client, illustrates the trap in Figure 1. Ernie sits at point A (crisis) with a vague vision at point B, and “just sell” actions often carry him away from the vision, since each easy sale needs new skills, gear, and labor. The trap is deceptive because occasional luck is mistaken for progress, “like believing that because you once won on a scratch-off card, the lottery is a good investment strategy.” The deeper claim: “Sustained profitability depends on efficiency. You can’t become efficient in crisis.” p. 39 (file not included in this release)

Traditional Accounting Is Killing Your Business (author’s heading)

Michalowicz traces the trap to the formula Sales − Expenses = Profit, formalized in the early 1900s and embodied in GAAP. It is logical but not “human sense,” and he lists three flaws.

• It goes against human nature: we spend whatever we earn and justify each expense.
• It exploits the Primacy Effect (explained in Chapter 2): by putting sales and expenses first, it makes owners “blind to profit,” which becomes an afterthought.
• It is complex and open to manipulation, as in Enron, which posted profits while going bankrupt.

An exchange with his accountant, also named Keith, makes the definitional point. Told he had a $15,000 profit, he asked where the cash was and learned it had “already” been spent, since this was “an accounting profit.” So the entrepreneur’s definition of profit is “cash in the bank. Cold. Hard. Cash. For us.” He does not reject GAAP’s three reports (income statement, cash flow statement, balance sheet), which he says give a holistic view, but calls the underlying formula “the Frankenstein formula.” p. 43 (file not included in this release)

Profit First Is Built for Humans and Happily Ever After (author’s headings, combined)

The answer is a system “designed for humans, not Spock,” meaning a person who would study statements, ratios, and KPIs weekly. Most owners are “Captain Kirk,” going on gut and bank balance, and, citing Charles Duhigg’s The Power of Habit, reverting to established habits under stress. So Profit First is “within your natural path,” in line with looking at the bank account, and “sits in front of your accounting,” flagging when to dig into the complex accounting with a qualified accountant. The Frankenstein ending serves as a warning that monster businesses have “killed marriages,” while the closing promise is that the business can become “an obedient, pasture-loving cash cow.” p. 45 (file not included in this release)

The “Take Action” step asks the reader to email him with the subject “I’ve Drawn the Line in the Sand” as a commitment.

Key Concepts and Distinctions

• Income versus profit (making versus taking money): Income is what the business brings in; profit is cash actually kept.
• Significance: It underlies the author’s collapse and his redefinition of profit as “cash in the bank.”
• Bank balance accounting: Making decisions from the bank balance you see, panicking when low and spending when high.
• Significance: It is the habit Profit First is built to harness and not break.
• The Survival Trap: Taking any sale to escape immediate crisis, which moves the business away from its vision.
• Significance: It explains why selling harder does not produce stability.
• Top line thinking: Focusing on revenue first, last, and always.
• Significance: It is the mind-set the old formula produces.
• Profit is a habit, not an event: Profit is built into every transaction, and does not wait for year-end or “someday.”
• Significance: It is the reason profit has to be taken first.

Essential Evidence and Examples

• The $15,000 “profit” with no cash: shows that accounting profit and spendable cash diverge, supporting the redefinition of profit.
• Ernie’s service creep: makes the Survival Trap concrete by showing how easy sales raise cost and complexity.
• Jason Fried’s pizza chain: shows that doubling locations can outrun sales and debt, supporting the claim that bigger is not better.
• The author’s own collapse: a lost windfall and last $10,000 show that skill at growth does not prevent a financial disaster, and that this can happen to a successful entrepreneur.

Chapter Conclusion and Significance

Michalowicz concludes that the monster is not defeated by selling more, working longer, or understanding accounting better, but by arranging the money so that profit, owner pay, and taxes are protected before expenses consume everything. His argument moves from his own failure to a general behavioral pattern, then to a structural cause in the accounting formula, and ends by presenting Profit First as the way to change outcomes without changing human nature. The chapter gives the book its reason for existing and its emotional register, and it sets up the behavioral principles of Chapter 2.

The case rests largely on the author’s experience and illustrative stories. He asserts, for instance, that “it’s rare to find a truly profitable business” without citing a figure, and that most entrepreneurs behave as he did. The chapter also leaves open how a system that “does not require massive mind-set change” will still demand the discipline the author later asks for. Those details come in Chapters 2 and 3.

Questions for Reflection

1. Michalowicz says the Survival Trap makes occasional luck look like progress. How would you tell, in your own decisions, whether a good result came from a clear vision or from happenstance?
2. He defines profit as cash in the bank and criticizes accountants’ “fictitious number.” What does his definition gain in clarity, and what does it leave out that GAAP is designed to capture?
3. The chapter claims that working with habits is more reliable than changing them. What evidence in the chapter supports this, and what would count against it?

Chapter 2: The Core Principles of Profit First

Open in PDF — p. 48 (file not included in this release)

Chapter Objective and Through Line

This chapter explains the reasoning behind the system and gives its first practical step. Michalowicz says his daughter’s piggy bank did not spark an immediate turnaround; the insight came months later, during a depressed period, from a PBS fitness expert who said lasting dietary change comes from changing the structure around our habits, starting with smaller plates. The author’s realization was that every dollar his company earned landed on “one huge plate,” his operating account, and he ate it all. The remedy is to change the structure and leave the habit alone.

From the diet advice he draws four principles (use small plates, serve sequentially, remove temptation, enforce a rhythm) and ties each to behavioral science: Parkinson’s Law, the Primacy Effect, out-of-sight-out-of-mind, and cash-flow rhythm. He then translates the principles into a new formula, Sales − Profit = Expenses, with a set of bank accounts and rules for using them.

The chapter ends by lowering the bar. Before the full system arrives in the following chapters, the reader opens a PROFIT account and transfers 1 percent of deposits, so that the habit starts before the mechanics are understood. It supplies the “why” that the account setup in Chapter 3 and the percentages in Chapters 4 and 5 depend on.

Chapter Structure at a Glance

1. The “small plate” insight: the fix for spending is to shrink what is available, not to try to change a habit, as the author recognized from the PBS fitness program and 401(k) deductions.
2. Four diet principles are mapped to behavioral science: Parkinson’s Law, the Primacy Effect, out of sight, and rhythm explain why each works.
3. Profit First answers the growth objection: setting profit aside forces the business to reveal which of its activities pay.
4. The new formula operationalizes the four principles: Sales − Profit = Expenses, with percentage allocations, sequential payment, hidden accounts, and a twice-monthly cadence.
5. A one-percent starting step lowers the bar: a PROFIT account and a 1 percent transfer begin the habit and build confidence.

Section-by-Section Argument

The chapter’s opening is unheaded, followed by the author’s own headings.

The small plate insight (analytical division, before the author’s first heading)

After his collapse, Michalowicz slid into depression and drinking. Watching PBS at night, he heard a fitness expert say that the way to eat less is to use smaller plates, since we fill whatever plate we are given and clean it. The takeaway for the author: “The solution is not to try to change our ingrained habits… but instead to change the structure around us and leverage those habits.” p. 49 (file not included in this release)

• Figure 2 shows his pattern: income rose and expenses rose at a similar rate (points A, B, C), profit appeared only briefly when income jumped before spending caught up, and then he was left with higher costs when sales settled. p. 51 (file not included in this release)
• The 401(k) analogy, from Thaler and Sunstein’s Nudge, shows that people who start rarely stop, and that their lifestyle adjusts to the smaller residual pay. His plan is to create the experience of having less cash than he really had.
• This led to the question “what if I took my profit first?”

The Four Core Principles of Profit First (author’s heading)

He first gives the four dietary principles: use small plates (smaller portions, fewer calories), serve sequentially (vegetables first), remove temptation (no junk food in the house), and enforce a rhythm (regular small meals rather than starving and bingeing). He cites a 2012 Journal of Consumer Research report that average American plate size grew 23 percent from 1900 to 2012, from 9.6 to 11.8 inches. p. 52 (file not included in this release) He then gives the business parallel for each.

• Parkinson’s Law (small plates): demand expands to match supply. The toothpaste tube makes the case: a full tube gets a big glop, a nearly empty one makes you both frugal and “extremely innovative.” If you extract profit first and remove it from sight, the “nearly empty toothpaste tube” forces you to think smarter. p. 55 (file not included in this release)
• The Primacy Effect (serve sequentially): “We place additional significance on whatever we encounter first.” The author shows two identical lists of words in reversed order (EVIL, HATE, ANGER, JOY, CARE, LOVE and the reverse), and most readers judge the evil-first list to be the sinner. Under Sales − Expenses = Profit, sales and expenses are the first words, so profit becomes an afterthought. p. 56 (file not included in this release)
• Remove temptation: once profit is allocated it should be moved out of immediate access, so you “work with what you do have,” and later releases from the profit account feel like a bonus.
• Enforce a rhythm: regular allocation (the 10/25 rule, explained in Chapter 6) prevents splurging on big deposits and panicking at dips, and lets the bank balances serve as a cash-flow indicator. He compares it to waves rolling onto a beach.

But If I Set Aside My Profits, How Will I Grow? (author’s heading)

He answers the usual objection by reversing it. Fast and healthy growth, he argues, comes from businesses that prioritize profit, not from plowing profits back, because reinvested profit is “just holding money temporarily (feigning profit).” Taking profit first forces you to test whether the business can afford its expenses, is streamlined, and has the right margins. It shows which activities make money, so you do more of those and fix or dump the rest.

• The specialist heart surgeon and the general practitioner illustrate the point: specialists attract premium customers while general practitioners refer serious cases away. His advice: “To grow the biggest and the fastest, you need to be the best at one thing you do.” p. 58 (file not included in this release)

The New Accounting Formula (author’s heading)

The system is introduced in the formula Sales − Profit = Expenses, described as “pay yourself first” combined with small plates and Grandma’s envelope system. Each principle becomes a rule. p. 59 (file not included in this release)

• Small plates: deposits go into the main INCOME account, which is only a “serving tray.” You periodically disperse all of it into other accounts in predetermined percentages. The five foundational accounts are Income, Profit, Owner’s Comp, Tax, and Operating Expenses (OPEX); advanced users add more in Chapter 10.
• Serve sequentially: “Always, always allocate money based upon the percentages to the accounts first. Never, ever, ever pay bills first.” Bills are paid only from OPEX. If there is not enough, the business is saying it cannot afford those expenses, and you eliminate them instead of pulling from the other accounts. p. 59 (file not included in this release)
• Remove temptation: move PROFIT and other tempting accounts out of arm’s reach, with an accountability mechanism that prevents access except “for the right reason.”
• Enforce a rhythm: do allocations and payables twice a month, on the tenth and the twenty-fifth, so you see how cash accumulates and where it goes.

He supports the approach with others who run similar systems: Jesse Cole paid off nearly $1 million in loans while growing, and Phil Tirone kept a studio apartment until he had enough profit to upgrade. José and Jorge took 7 to 20 percent profit monthly from their first months. p. 61 (file not included in this release)

Lower the Bar (author’s heading)

Drawing on Chip and Dan Heath’s Switch, he asks the reader to take one small step, not a large one. Open a new checking account, nickname it PROFIT, and from now on transfer 1 percent of each deposit into it, then carry on as before. A $1,000 deposit sends $10; $20,000 sends $200. The point is psychological: “You’ll never miss that 1 percent. It is a low bar.” You won’t get rich, but “you will get a wealth of confidence,” and the aim is “to win over your mind.” p. 62 (file not included in this release)

The action steps are to trust the process, open one account called PROFIT (as a checking account, ignoring interest), and transfer 1 percent of your current money to seed it and leave it alone.

Key Concepts and Distinctions

• Small plates (Parkinson’s Law): Available supply expands to match consumption, so reduce what is visible.
• Significance: It explains why taking profit off the top makes the business frugal and innovative.
• The Primacy Effect: We give extra weight to whatever comes first.
• Significance: It is the case for putting profit at the front of the formula.
• Sales − Profit = Expenses: The Profit First replacement for the traditional equation.
• Significance: It converts expenses into a constraint set by what remains, which is the system’s core mechanism.
• Sequential allocation versus paying bills first: Percentages are moved before any bill is paid, and bills draw only from OPEX.
• Significance: It prevents profit, owner pay, and tax from being consumed by operations.
• Rhythm (10th and 25th): A fixed twice-monthly cycle of allocation and payment.
• Significance: It replaces reactive cash handling with a predictable cycle.

Essential Evidence and Examples

• The reversed word lists: a simple demonstration that order alone changes attention, which supports the claim that profit must come first.
• The toothpaste tube: shows that scarcity produces both frugality and ingenuity, which supports the claim that taking profit leaves a business more innovative.
• Specialist versus general practitioner: supports the argument that focus, revealed by taking profit first, drives growth.
• The 1 percent transfer: a deliberately trivial action meant to prove the system to the owner and form the habit.

Chapter Conclusion and Significance

The chapter’s conclusion is that profit is secured by redesigning the environment around money. The author derives four rules from a diet program, justifies each with behavioral science, and expresses them as a formula and account structure that an owner can follow without changing temperament. The chapter establishes the framework (the five accounts, allocation before payment, hidden reserves, twice-monthly rhythm) that Chapters 3 through 6 develop in detail.

Some qualifications remain. The author says the system will not guarantee cash is always available: “I am not saying the money will automatically appear.” The behavioral claims are presented through analogy and anecdote more than through evidence tied to small business results, and the dietary parallel carries much of the argument. The percentages are not given yet, so the 1 percent step is a placeholder and not a target.

Questions for Reflection

1. Michalowicz argues that scarcity makes people both frugal and innovative. Under what conditions might taking profit first instead starve a business of necessary investment?
2. How well do the four dietary principles transfer to a business account? Which parallel is strongest, and which depends most on analogy?
3. The author says reinvested profit is not truly profit. How would you distinguish genuine investment from “feigning profit” in a particular expense?

Chapter 3: Setting Up Profit First for Your Business

Open in PDF — p. 64 (file not included in this release)

Chapter Objective and Through Line

This chapter turns the principles of Chapter 2 into a concrete bank structure. Michalowicz starts from his mother’s envelope system, in which she split each paycheck into labeled envelopes and never borrowed between them, and presents Profit First as “the envelope system applied to business and modernized by using bank accounts.” Her income varied, yet she “always had enough” because each envelope had a purpose and stayed sealed until needed.

The argument is that the system should be built on top of what owners already do, which is look at their bank balance. Accountants say not to, but the author keeps the habit and adds “guardrails around it.” Multiple accounts at the bank mean each balance carries a purpose, so the daily glance becomes accurate information. The chapter then specifies the accounts: five foundational ones at a primary bank and two “no-temptation” savings accounts at a second bank.

Chapter Structure at a Glance

1. The envelope system as a model: fixed allocations, sealed envelopes, and no borrowing let a variable income cover needs.
2. Bank balance accounting is kept, not fought: owners will check balances anyway, so the system makes those balances meaningful.
3. Five foundational accounts are opened at the primary bank: Income, Profit, Owner’s Comp, Tax, and OPEX.
4. Two no-temptation accounts are opened at a second bank: PROFIT HOLD and TAX HOLD, deliberately inconvenient.
5. Objections are answered and the bank is chosen: the accounts must be at a bank, and the bank must fit the roles of convenience and inconvenience.

Section-by-Section Argument

The envelope system (analytical division, before the first heading)

His mother, who worked part-time, split her pay every other week into envelopes labeled “Food,” “Mortgage,” “Community,” “Fun Money,” and “Vacation,” plus one in German meaning “In case of emergency.” The allocation was 50 percent to the mortgage, 15 percent to vacation, 5 percent to fun money, and 10 percent each to food, community, and the emergency envelope. p. 64 (file not included in this release)

• She never borrowed from another envelope. The grocery budget was whatever the food envelope held that week, which could mean peanut butter and jelly or more.
• The mortgage allocation was set at 50 percent although 40 percent would normally suffice, which built in a cushion for weeks when “normal ain’t always so normal.”
• Readers report that parents and grandparents used jars or a compartmented steel box. The lesson is that fixed purposes and sealed envelopes make uneven income manageable. p. 65 (file not included in this release)

Bank Balance Accounting (author’s heading)

Here he explains why the system must be built around the bank balance. The accountant’s weekly routine of reconciling, reviewing statements, and running ratios is something he cannot do himself, so owners do what he calls bank balance accounting: log in, read the balance, and act (collect and sell when low, invest when high). It works, in his words, “Kinda,” and it fails because nothing is left to pay yourself. Profit First keeps this habit: you log in, and each account tells you what the money is for. “We are not going to change your behavior; we are going to put guardrails around it.” p. 67 (file not included in this release)

The Five Foundational Accounts (author’s heading)

The accounts are listed as INCOME, PROFIT, OWNER’S COMP, TAX, and OPEX, and they are the “bones” of the structure. All five are set up as checking accounts, because their flexibility “far outweighs” any interest from savings accounts. Nicknames matching their purposes should be used, as Mom labeled her envelopes. p. 68 (file not included in this release)

• The existing primary account is renamed OPEX, since bills are probably paid from it.
• Deposits are redirected to the new INCOME account. Checks simply go into it; credit card and ACH payers need updated bank information. He estimates half an hour of work, or an hour with many automated payments.

Two “No-Temptation” Accounts (author’s heading)

Profit and tax money should be out of sight. Profit taken back into the business shows an unwillingness to run on the allocated operating budget, and tax money is the government’s, so borrowing from it is theft from the government. At a second bank, one the owner has not used before, set up two savings accounts, PROFIT HOLD and TAX HOLD, and link them to the PROFIT and TAX accounts at the primary bank. They are savings accounts because the money will pool and earn interest. p. 69 (file not included in this release)

Why not skip the primary-bank PROFIT and TAX accounts and send money directly from INCOME to the hold accounts? He gives two reasons.

• Transfers between banks are not instant and can take three days or longer, so the balance looks as though the money is still there.
• The goal is instant, accurate knowledge. A same-bank transfer is usually immediate, so money lands on its “plate” at once, and the interbank transfer to the hold accounts can then follow without confusing the balances.

Two Frequently Asked Questions (author’s heading)

• “I haven’t ever been profitable in the past, so how can I take my profit now?” He answers with Parkinson’s Law: owners already spend all they have and stretch it in lean times, so removing profit first means operating on less, which they have done before. “Nothing changes if nothing changes.”
• “Can’t I just do this on a spreadsheet or in my accounting system?” His reply is to ask how that has served so far. “Your current bank balance is always going to be a stronger determinant of your behavior,” so the system must live at the bank where it cannot be missed. p. 70 (file not included in this release)

Picking the Bank (author’s heading)

The two banks have opposite jobs. The primary bank should offer easy viewing, easy transfers from INCOME, and bill payment from OPEX; the second should offer no convenience options. Peter Laughter, the author’s friend, asked a branch manager for “the most inconvenient options you have,” wanting to withdraw only by visiting and requesting a certified check. p. 71 (file not included in this release)

• Banks may not fit your needs, and you can leave: in 2005 he moved to Commerce Bank, which was open nights and weekends.
• Feedback shows that only a few large banks waive fees, but many regional and local banks and credit unions are “plug and play.” If your bank resists minimum balance and transfer fees, ask it to waive them; if it refuses, move on. p. 72 (file not included in this release)

Take Action: Get Your Business Profit-Ready (author’s heading)

Step 1: open the five checking accounts, keeping the existing primary account as OPEX and negotiating fees with the manager. Step 2: open PROFIT HOLD and TAX HOLD at another bank, able to draw from the matching primary-bank accounts. Step 3: enable no convenience options on them, meaning no online viewing, no checkbook, and no debit card. p. 73 (file not included in this release)

Key Concepts and Distinctions

• The five foundational accounts: INCOME, PROFIT, OWNER’S COMP, TAX, and OPEX, all held as checking accounts at the primary bank.
• Significance: They are the “plates” that give each balance a purpose.
• No-temptation accounts: PROFIT HOLD and TAX HOLD, savings accounts at a second bank with no convenience features.
• Significance: They make it difficult to borrow from profit or tax money.
• Convenience versus inconvenience: The primary bank is optimized for access, the second for friction.
• Significance: It puts the temptation-removal principle into the structure of the banking.

Essential Evidence and Examples

• Mom’s mortgage cushion: a 50 percent allocation against a 40 percent need shows how a built-in buffer lets variable income cover essentials.
• Peter Laughter’s request for inconvenience: illustrates the no-temptation principle taken to its extreme.

Chapter Conclusion and Significance

The chapter concludes that Profit First is implemented in banking, not in software or spreadsheets, because the bank is where owners already look and act. Two layers do the work: five accounts that tell you what each dollar is for, and two hidden accounts that protect profit and tax money from yourself. The chapter converts the behavioral principles of Chapter 2 into a structure that can be built in an afternoon.

The chapter does not say how much goes into each account; Chapter 4’s assessment and the allocation chapters supply the numbers. It also admits that bank cooperation varies.

Questions for Reflection

1. Michalowicz rejects doing Profit First in a spreadsheet because behavior follows the bank balance. What does this claim assume about how owners decide, and how could you test it?
2. His mother kept a 10 percent cushion on the mortgage and an emergency envelope. How do those two buffers differ in function, and where would each appear in a business account structure?
3. The no-temptation design relies on friction. When is deliberately making your own money hard to reach a sound strategy, and when might it create real risk?

Chapter 4: Assessing the Health of Your Business

Open in PDF — p. 74 (file not included in this release)

Chapter Objective and Through Line

This chapter walks the reader through the Instant Assessment, a one-page exercise that compares how the business actually divides its money with a set of target percentages. Michalowicz opens with Lisa Robbin Young, a business coach who completed it while helping edit the first edition and was “really pissed off” at what she had been overspending. After resisting, she implemented Profit First, replaced her tax-time “profit” with a quarterly bonus she could feel, cut hours, shifted her audience, and reports that her revenue has doubled every month since. The chapter’s thesis is that owners must see the real numbers before they can change them, and that the process is quick even if it is painful.

The method works only on cash. “Profit First is a cash-management system,” so nothing is measured on accrual: “Did you get the cash or not? And did you spend the cash or not?” The assessment strips a business down to Real Revenue, sorts last year’s spending into four buckets (Profit, Owner’s Comp, Tax, Operating Expenses), and shows the gap between actual and target in each.

The chapter’s emotional aim matters as much as its procedure. He wants readers to move from “How can I make my business bigger?” to “How can I make my business better?”, and he closes with a fallback for those who cannot face the exercise yet.

Chapter Structure at a Glance

1. Facing the truth is the entry price: denial feels easier, but the assessment is the first step of the system, and Lisa’s story shows reality can be survived.
2. Real Revenue is computed first: materials and subcontractors are subtracted from top-line revenue so businesses can be compared on what they actually earn.
3. Actual spending is sorted into four buckets: Profit, Owner’s Comp, Tax, and Operating Expenses must add up to Real Revenue.
4. Targets and gaps are calculated: the Target Allocation Percentages for the right revenue tier produce target dollars, a Delta, and an increase-or-decrease Fix.
5. A worked example makes the result concrete: the law firm shows where a business bleeds and what it must cut.
6. Emotional and edge cases are handled: frugality is not enough, new businesses start differently, and the overwhelmed have a minimum action.

Section-by-Section Argument

Why face the Instant Assessment (analytical division, before the first heading)

Michalowicz expects shock and anger and says it is even more sobering for owners who think they are doing fine. Denial “lets you ignore reality until reality punches you in the face.” Lisa had a five-figure cash flow with money “all over the map,” did not realize she was overspending because inflow still exceeded outflow, and felt only numbness. p. 75 (file not included in this release)

• Two years in, she finished her taxes earlier than in five years, with money set aside, and was “only working a few hours a week.”
• The author takes her revenue doubling as confirmation that Profit First “triggers growth because it requires us to focus, streamline and innovate.” p. 75 (file not included in this release)

The (Almost) Instant Assessment (author’s heading)

Before starting, gather the last full year’s P&L, each owner’s tax return for that year, and the year-end balance sheet; if they are unavailable, “we can get close enough.” The form is Figure 3, with a full-page version in Appendix 2. The ballpark percentages come from surveying “fiscally elite (very profitable) companies.” The steps follow the form’s cells. p. 77 (file not included in this release)

• A1, Top Line Revenue: total revenue from sales for the last twelve full months.
• A2, Material & Subs: enter the cost of materials (not labor) if you are a manufacturer or retailer, or if more than 25 percent of sales come from resale or assembly of inventory. Enter subcontractor costs (paid by project and handling their own taxes) if they deliver the majority of your service; combine both if you have both. Put $0 if you are a service company whose employees do the work, if these costs are under 25 percent of Top Line Revenue, or if you are unsure. p. 78 (file not included in this release)
• A3, Real Revenue: A1 minus A2. The point is that you have little control over pass-through costs, so they do not drive profitability. A $5,000,000 real estate agency paying $4,000,000 in agent commissions is “really a $1,000,000 business,” and a $3,000,000 staffing firm paying subs $2,500,000 is a $500,000 business. Real Revenue is not gross profit, because it subtracts only materials and subs and treats employees as an operating cost. p. 80 (file not included in this release)
• A4, Profit: cumulative profit in the bank or distributed as a bonus on top of salary. If it is neither, “you don’t really have a profit.”
• A5, Owner’s Comp: regular payroll to all owners, not profit distributions.
• A6, Tax: only what the company paid or reimbursed, and probably $0, including owners’ income taxes and corporate taxes. p. 81 (file not included in this release)
• A7, Operating Expenses: everything else the business paid. Check that A4 + A5 + A6 + A7 equals Real Revenue (A3), adjusting A7 up or down to balance, and that A3 + A2 equals A1. The goal is “the ballpark,” not reconciliation “to the penny.” p. 82 (file not included in this release)
• B4 to B7, TAP: enter the Target Allocation Percentages for your Real Revenue range from Figure 4. TAPs are “the targets you are moving toward,” not the starting point. Examples: $722,000 uses column C, $225,000 column A, $40,000,000 column F.
• C3 to C7, PF $: copy Real Revenue to C3, then multiply by each TAP for the target dollars.
• D4 to D7, Delta: Actual minus PF $. Negative means a shortfall. Most businesses are short on Profit, Owner’s Comp, and Tax and over on Operating Expenses.
• E4 to E7, Fix: write “increase” where Delta is negative and “decrease” where positive. p. 84 (file not included in this release)

What Do These Percentages and Numbers Mean? (author’s heading)

The Figure 4 percentages are “typical ranges” and “an excellent starting point.” They are reached by small steps.

Figure 4, Target Allocation Percentages, transcribed from the book’s image p. 84 (file not included in this release)

He sorts companies into six revenue tiers, each with a changing role for the owner: p. 85 (file not included in this release)

• Under $250,000: the owner is the key employee, often a freelancer, and can raise profit and pay percentages further.
• $250,000 to $500,000: employees and basic systems raise Operating Expenses while Owner’s Comp adjusts down.
• $500,000 to $1,000,000: more systems and people, and a push toward profit, since growth to $5,000,000 is hardest.
• $1,000,000 to $5,000,000: systems become mandatory and larger allocations go to Operating Expenses; the owner works on the business.
• $5,000,000 to $10,000,000: a management team forms and most of the owner’s income comes from profit.
• $10,000,000 to $50,000,000: stable, predictable growth, with the owner’s income almost entirely profit distributions. p. 86 (file not included in this release)

Example of a Completed Instant Assessment (author’s heading)

A law firm’s results (Figure 5) show a business that is “basically a break-even business” with only $5,000 in its Profit account. It should add $118,000 a year in profit, its two owners’ combined $190,000 salary is too high and should be cut by $67,000, and Operating Expenses are over by more than $141,000. Taxes should rise as the business becomes healthier. The prescription is to cut owners’ salaries and operating costs, possibly including staff, which “will require courage, and it is going to be painful.” The section ends: “Profitability isn’t an event; it’s a habit.” p. 87 (file not included in this release)

Don’t Panic! (author’s heading)

Michalowicz had already been frugal after his collapse, with a $1,000 office in place of $14,000, discounted furniture, and a homemade whiteboard, yet his own assessment showed him still bleeding. The problem was not how little he paid for each line item but that some items should not exist: he sublet the office he had wanted mainly to feel legitimate, and moved into free space at a friend’s cookie factory. p. 89 (file not included in this release) Cost cutting becomes “an almost enjoyable strategic challenge” once the harsh truth is faced. He ends with reassurance: “You are not a fool.”

If Your Business Is Brand-New (author’s heading)

A new business with no revenue should start immediately, because it forms the habit and prevents bad ones. Use the assessment percentages as targets but start at 1 percent for PROFIT, 50 percent for OWNER’S COMP, and 15 percent for TAX, and step up through quarterly adjustments. Skip the advanced strategies at the back of the book until the business has been active at least a year. p. 90 (file not included in this release)

Take Action and Please Read This (author’s headings, combined)

The only action step is to complete the assessment now. For anyone overwhelmed or angry, there is a fallback: set up a PROFIT account at a separate bank and move 1 percent of every deposit into it, then return to the book when ready. “You are normal. Totally, completely, 100 percent normal.” p. 91 (file not included in this release)

Key Concepts and Distinctions

• Real Revenue: Top Line Revenue minus materials and subcontractor costs, where those are significant.
• Significance: It measures the money the company actually controls and puts differently structured businesses on equal footing.
• Real Revenue versus gross profit: Real Revenue subtracts only materials and subs, while gross profit also subtracts employee time.
• Significance: Employees are paid regardless of daily sales, so they are treated as operating cost, and gross profit can be manipulated.
• TAP (Target Allocation Percentage): The share of each deposit assigned to Profit, Owner’s Comp, Tax, and Operating Expenses at a given revenue tier.
• Significance: It is the target the business moves toward in steps.
• Delta and Fix: The gap between actual and target dollars, and the instruction to increase or decrease.
• Significance: It turns diagnosis into a direction for each category.

Essential Evidence and Examples

• Lisa Robbin Young: shows that a painful assessment can precede restructuring, lower overhead, and growth.
• The law firm assessment: shows how the Delta column exposes an overpaid ownership and bloated expenses at once.
• The real estate agency and staffing firm: show why Real Revenue can be a fraction of top-line revenue, which changes how size is judged.

Chapter Conclusion and Significance

The chapter concludes that the first act of Profit First is honesty: compare reality to a target, accept the gap, and decide what to change. The assessment gives a baseline in minutes and shows which categories are over or under by how much. The shock is part of the method, which is why the chapter pairs the procedure with reassurance and a minimal fallback.

The author is explicit that the numbers are approximate and the targets are a direction and not a verdict. He says the next chapter helps refine them for the specific business. Whether a ballpark built from “very profitable” companies fits every industry is not tested here; his answer is that the numbers self-adjust as the system is implemented.

Questions for Reflection

1. Real Revenue removes materials and subcontractors from the picture. What does this reveal about a business, and what might it conceal about risk or margin on pass-through work?
2. The author’s own frugality did not stop his bleeding until he removed whole expenses. What distinguishes cutting a cost from eliminating the need for it, and how would you apply that to an expense of yours?
3. The assessment is built to produce discomfort. Does that discomfort help owners act, or could it lead some to quit? How do the chapter’s closing sections try to manage that risk?

Chapter 5: Allocation Percentages

Open in PDF — p. 92 (file not included in this release)

Chapter Objective and Through Line

Michalowicz’s task in this chapter is to turn the Instant Assessment from Chapter 4 into a personalized set of targets. The system begins with “setting allocation percentages, the amount you will transfer to PROFIT, OWNER’S COMP, and TAX accounts” (p. 93 (file not included in this release)). The opening story, in which a speaker chases an “eighty percent” close rate that her instructor meant as “eighteen,” makes his point about targets: if you work toward a number and believe it is possible, you can “blow past the ‘reasonable’ numbers others have set.”

The central problem is behavioral rather than arithmetical. Owners tend to fail in one of two ways. Some stall in analysis paralysis, perfecting percentages before they act. Others jump in too fast and take a 20 percent profit allocation on day one. His answer is to separate the destination from the starting point. Target Allocation Percentages (TAPs) are where you are heading, and Current Allocation Percentages (CAPs) are where you are now. You move from one to the other in small, regular steps.

The chapter then sets the three TAPs (Profit, Owner’s Comp and Tax), each with its own research method, and ends with a calculation showing why the Tax percentage is lower than the tax rate. Chapter 6 supplies the rhythm for putting them to work.

Chapter Structure at a Glance

1. Two opposite mistakes are named: over-analysis that prevents starting, and over-ambition that breaks the system in the first week.
2. TAPs and CAPs are distinguished: targets are aspirational, current percentages are the real starting point, and the gap is closed gradually.
3. The Profit TAP is set by research: public-company comparisons, your own best year, or the Instant Assessment figure, with a case for pushing profit well past 5 percent.
4. The Owner’s Comp TAP is set by the real work you do: pay yourself the going rate for your actual job, and do not cut your own pay to make the numbers work.
5. The Tax TAP covers business and owner taxes: the percentage comes from your tax history, your accountant, or a default, then is adjusted for what is actually taxable.
6. Action steps lock in the plan: set the TAPs, update the assessment, and set CAPs one step better than history.

Section-by-Section Argument

Two Common Problems (author’s heading)

The two warnings frame everything else. The first is “analysis paralysis”: if you are lost in “a research- and percentage-tweaking rabbit hole,” stop and move on, because “Perfectionism kills every dream—better to just start.” The second is the author’s own habit of acting too big and too fast, then blaming the system when the real cause was poor preparation.

• The blood-drive analogy carries the second warning: five gallons at the first drive would kill you, but small donations over time reach five gallons cumulatively. A 20 percent profit allocation on day one is his example of the mistake.

The two warnings lead to the TAP/CAP distinction.

Target and Current Allocation Percentages (author’s headings, combined)

TAPs are “simply the targets you are moving toward,” and he stresses that they are “not—I repeat, are not—your starting point.” He derived them from roughly one thousand “fiscally elite” companies plus companies that implemented Profit First, and even a business already beating them should push to become “the elite of the elite.”

The CAP is “where your business is today,” adjusted “slowly but consistently.” A company with no historical profit allocation has a profit CAP of 0 percent, and his example path is 1 percent, then 3 percent the next quarter, then 5 percent (p. 95 (file not included in this release)).

• Taking every penny yourself starves the business, which now lives on the leftovers.
• The method is “a series of many small steps in a repeating pattern,” replacing the “erratic, noisy rhythm” of most owners.

Your Profit Target Allocation Percentage (Profit TAP) (author’s heading)

The Instant Assessment already gives a starting TAP, and refining it is optional. Three ways to set a more specific figure are offered:

• Public companies: Look up at least five companies in your industry or a similar one, using income statements for the last three to five years. For each year, divide net income by total sales/revenue, average the results, and use the overall industry average as your Profit TAP.
• Your own best year: Review three to five years of tax returns and find the most profitable year by percentage, not dollars. A billion-dollar company with a million in profit is in trouble; a five-million-dollar company with the same million is not.
• The easy route: Pick the percentage from the Instant Assessment based on projected revenue, using revenue for the last twelve months.

He argues the profit CAP should pass 5 percent quickly, because the PROFIT account funds owner profit distributions and also acts as a rainy-day fund. His rule of thumb, if sales stopped completely, is:

• 5 percent profit allocation = 3 weeks of operating cash
• 12 percent = 2 months of operating cash
• 24 percent = 5 months of operating cash

Doubling the allocation almost triples the runway because a higher allocation means a more efficient business with lower operating expenses, so you both save more and spend less (p. 97 (file not included in this release)).

A sidebar, “Fat Margins Draw Stiff Competition,” qualifies the push for profit. Very high margins, such as 50 percent to Profit and 10 percent to operating expenses, will be noticed by competitors, who can afford to cut prices. His advice is to “milk them for all they’re worth” while you have them and keep innovating.

Owner’s Comp TAP (author’s heading)

Owner’s Comp is the pay for the work owner-operators do for the company, and it should be “on a par with the going rate for the work you do,” meaning the salary you would pay your replacement. Equity members who do not work in the business receive only profit distributions. Two options are given:

• Real-work method: A “CEO” at a small company spends only about 2 percent of the time on real CEO work. Set salaries based on what you do 80 percent of the time and what you would pay employees for those jobs. Add up the salaries for all working equity owners. The percentage of revenue must at minimum cover that total, and he advises setting it at one and a quarter times the salaries to allow for raises and revenue swings. His example is four owners drawing $50,000 each on $1,000,000 revenue, which requires at least 25 percent.
• Assessment method: Use the percentage from the Instant Assessment for your revenue range. The money is split among working owners by negotiated agreement.

The reason for a separate account is that “you are the most important employee.” Business structure changes how the money must legally flow, but the allocation works the same way, so he recommends an accountant, ideally a certified Profit First Professional.

The Rodrigo story, “Don’t Underpay Your Most Important Employee,” drives the point home. On $350,000 revenue, 35 percent gives just over $122,000 of Owner’s Comp, yet Rodrigo took roughly $30,000 while paying three employees $65,000 each, because he wanted to grow the business, not do the work (p. 100 (file not included in this release)).

Michalowicz agrees with Gerber’s “on versus in” idea but says the shift from working in the business to working on it “happens over time.” That is why the assessment percentages for owners shrink as revenue grows:

• Under $500,000 you do about 90 percent of the work and spend 10 percent systematizing it.
• Past $500,000 you are a systems developer 20 percent of the time, a manager 10 percent and an employee 70 percent, and the salary percentage drops further past $1 million.
• You will probably keep handling the big sales, and “getting back in your business is the best way to create systems.”

His rule: “don’t cut your salary to make the numbers work.” Start from your CAP and increase it by 1 percent each quarter.

Your Tax TAP (author’s heading)

The Tax account pays the business’s direct tax liabilities and also the owners’ personal income taxes (reimbursing taxes withheld from S or C corporation paychecks). “All taxes (including, scratch that, especially yours) are paid by your business, not you.” Greg Eckler, who had $30,000 in his TAX account and needed only $10,000, illustrates the peace of mind (p. 103 (file not included in this release)).

The system works with Real Revenue and does not aim for accounting “to the exact penny,” which is the bookkeeper’s and accountant’s job. Three ways to find the Tax TAP:

• Divide personal plus business taxes by Real Revenue for each of the last three years.
• Divide the accountant’s estimated year-to-date tax by year-to-date Real Revenue.
• Use 35 percent for U.S. businesses, or the average prevailing individual rate at your income for other countries. He prefers guessing a little high and getting a refund to coming up short.

The “Little Simple Math” explains why the assessment shows about 15 percent against a 35 percent rate. After Profit, Owner’s Comp and Tax are set aside, 40 to 60 percent is left for operating expenses. Expenses are generally untaxed, so only the remainder is taxed. If OPEX is 55 percent, 45 percent is taxable, and 45 percent times 35 percent is approximately 16 percent (p. 105 (file not included in this release)).

Take Action: Apply Your Advanced Knowledge (author’s heading)

• Step 1: Determine custom Profit, Owner’s Comp and Tax percentages and set them as TAPs, “the X on the map” but “not where we are starting.”
• Step 2: Update the numbers in the Instant Assessment chart.
• Step 3: Set CAPs 1 percent “better” than history for the rest of the quarter. Raise Profit, Owner’s Comp and Tax each by 1 percent and cut Operating Expenses by 3 percent. Push the CAPs further every quarter.

Key Concepts and Distinctions

• Target Allocation Percentage (TAP): The percentage of revenue each account should eventually receive, based on industry data and your own history.
• Significance: It sets a direction without being a starting requirement.
• Current Allocation Percentage (CAP): Where the business is today, adjusted gradually toward the TAP.
• Significance: It is the practical lever, protecting the business from overnight shock.
• Owner’s Comp as a market wage: Owners are paid the going rate for the work they actually do, not a sacrificial remainder.
• Significance: It ties pay to function, with the percentage shrinking as systems replace the owner’s labor.
• Tax percentage versus tax rate: The Tax TAP is the tax rate applied only to the share of revenue left after operating expenses.
• Significance: It explains why about 15 percent can cover a 35 percent rate.

Chapter Conclusion and Significance

The chapter’s conclusion is that percentages are tools for action, not objects of perfection. The targets come from elite companies and your own best results, but the working numbers are your CAPs, which rise gradually until the three reserved accounts and the shrinking OPEX plate reflect a healthier business. Profit protects against downturns, Owner’s Comp reflects real labor and keeps the owner from servitude, and the Tax account removes surprise liabilities.

Some tensions remain. The Tax and Owner’s Comp figures depend on structure and jurisdiction, so the author repeatedly sends readers to their accountant, and his advice to push profit hard sits beside his warning that fat margins invite price cutting.

Questions for Reflection

1. Michalowicz warns against both analysis paralysis and moving too fast. Which one is your more likely failure, and how would the TAP/CAP approach address it?
2. The longevity rule says doubling the profit allocation nearly triples business runway. Does his explanation (a more efficient business with lower expenses) fully account for that, and what would the rule assume about the business?
3. He argues owners should pay themselves the going rate for what they actually do, even when that is a lot of ordinary work. How does this fit his claim that the owner should eventually work on the business and not in it?

Chapter 6: Putting Profit First into Motion

Open in PDF — p. 107 (file not included in this release)

Chapter Objective and Through Line

This is the book’s implementation chapter. Michalowicz promises to teach the reader “exactly how to implement Profit First, step by step, day by day, month by month” (p. 109 (file not included in this release)). The chapter follows a timeline: Day One, Week One, the twice-monthly rhythm, the first quarter, and the first year. Each stage has one job, which is to install a habit before it asks the owner to push for more.

The argument rests on two ideas. First, you do not start at your Target Allocation Percentages. You start at your historical percentages plus 1 percent, set so small that “there was no excuse not to try it.” Second, the system works because of rhythm. Money comes into one account, is divided on fixed dates by fixed percentages, and is paid out on a schedule, so the owner stops reacting to each bill and starts seeing the pattern of cash flow. The story of Jorge Morales and José Pain of Specialized ECU Repair, who applied the idea from two paragraphs in an earlier book, frames the chapter and ends it: Profit First as “a way of life. For all of life.”

The chapter sits between Chapter 5, which set the targets, and the debt and expense-hunting chapters that follow, which supply the cash needed to move the percentages upward. Its role is to turn theory into a routine.

Chapter Structure at a Glance

1. Prepare the people and the accounts: bring the accountant and bookkeeper on board and label the foundational accounts with CAP and TAP.
2. Find the starting percentages: calculate Day Zero from history, then add 1 percent to Profit, Owner’s Comp and Tax and subtract 3 percent from Operating Expenses.
3. Make the first allocation and cut expenses: move available cash through INCOME on Day One, then cut at least 10 percent of expenses in Week One to fund the new allocations.
4. Run the tenth and twenty-fifth rhythm: a five-step routine that replaces ad hoc bill paying.
5. Take the quarterly distribution and step the percentages up: 50 percent of PROFIT goes to the owners, and the CAPs move closer to the TAPs.
6. Close the year and manage the reserve: reconcile taxes against the TAX account and decide what to do with excess profit reserve.

Section-by-Section Argument

Day One (author’s heading)

1. Tell Your People. Jorge and José did a yearly projection with their bookkeeper and accountant before choosing a starting profit percentage, and their accountant eventually became a full supporter. Michalowicz warns that most accountants and bookkeepers will not get it, because they “grown up under the laws and rules of the past” and the established rule is to budget and stick with it. His recommended responses are escalating:

• Give a progressive accountant the book and point her to ProfitFirstProfessionals.com for training and tools. He says the site lists professionals who use the system themselves.
• If she objects, ask whether she has hands-on experience with Profit First or a similar pay-yourself-first system and can explain why it fails.
• Ask how many of her clients are consistently profitable. If she will not support you, find a trained accountant, since “you are the client.”

2. Set Up Your Accounts. The five foundational accounts must already exist at the primary bank (INCOME, PROFIT, OWNER’S COMP, TAX and OPEX), with two more at the “no-temptation bank” (PROFIT HOLD and TAX HOLD). He insists these are real bank accounts, not “a spreadsheet or in your accounting system” and “absolutely” not “in your head.” Each account is nicknamed with its CAP and, in parentheses, its TAP, for example “PROFIT 8% (TAP 15%).” That way the current percentage and the target are visible within seconds of logging in.

CAPs: start easy. Day Zero is your historical percentage for each account, and Day One is Day Zero plus 1 percent for Profit, Owner’s Comp and Tax, with OPEX reduced “by the cumulative of the percentage adjustments.” Jorge began at 2 percent, reasoning that “if your business can’t afford to set aside two percent of your revenue, it’s probably not a business worth pursuing” (p. 114 (file not included in this release)). The starting CAPs are used for the rest of the current quarter, whether the next quarter begins next week or in ninety-one days.

How to find Day Zero, as he gives it:

• Profit: 0 percent in most cases. Money taken out whenever cash was sitting around counts as Owner’s Comp, and a profit shown on the income statement does not count if you only took money to support your lifestyle.
• Owner’s Comp: Everything the owners received this year in paychecks or distributions, divided by Real Revenue. The owners’ tax returns show it.
• Tax: Only taxes the business paid, directly or on the owners’ behalf. If owners paid their own income taxes personally, they are not counted. For most businesses this is 0 percent or a very low figure.
• Operating Expenses: Everything else on the income statement, except what was adjusted to get Real Revenue.

The numbers “do not need to be perfect”; the system “is self-correcting.”

His worked example comes from his old company, Olmec Systems: on just over $1 million revenue in 1999, the partners took home $40,000 (Owner’s Comp 4 percent, OPEX 96 percent, Profit and Tax 0 percent). After the adjustment the accounts read Profit 1 percent, Owner’s Comp 5 percent, Tax 1 percent, OPEX 93 percent. That meant $50,000 of pay, $10,000 of profit and $10,000 of tax reserve, with the business forced to run on $930,000 instead of $960,000.

3. Make Your First Distributions. Take the balance of your original primary account (now OPEX), subtract outstanding checks and payments, and transfer the remainder into INCOME. Then divide INCOME among PROFIT, OWNER’S COMP, TAX and OPEX by the CAPs. His example is $5,000 less $3,000 in pending items, leaving $2,000 allocated as $20 to PROFIT, $100 to OWNER’S COMP, $20 to TAX and $1,860 to OPEX. This allocation is the only thing ever done with the INCOME account other than receiving deposits. The picture is deliberately “ugly,” because the clarity motivates cutting expenses and raising profitability.

Week One: Cut Expenses (author’s heading)

Money has to come from somewhere, and there are “only two ways to do that: by increasing sales and cutting expenses.” Sales take time, while he says most businesses can cut 10 to 20 percent of expenses overnight (unused memberships, impressive office space, unhelpful staff).

• Print the last twelve months of expenses and all recurring expenses, add them, and multiply by 10 percent. “You must cut costs by 10 percent. Now! No if, ands, or buts!”
• The 10 percent exceeds the 3 percent needed because bills do not disappear overnight and another 3 percent moves to PROFIT, OWNER’S COMP and TAX each of the next two quarters.
• Method: cancel whatever you do not need, then negotiate every remaining expense except payroll.
• Jorge and José run the business on “what they can afford to do today, not what they hope to be able to afford someday.”

Twice a Month: The Tenth and Twenty-Fifth (author’s heading)

Debra Courtright, a bookkeeper, taught Michalowicz to do all accounting on two fixed dates, the tenth and twenty-fifth (or the prior business day if either falls on a weekend or holiday). Doing so made him less reactive, exposed unnecessary small recurring bills, and made him pay vendors on time.

The five steps:

• Step One: Deposit all revenue into INCOME.
• Step Two: On each date, transfer the prior two weeks of deposits to the “small plate” accounts by CAP, adding to any balance already there. His example allocates $10,000 as $100 to PROFIT, $500 to OWNER’S COMP, $100 to TAX and $9,300 to OPEX.
• Step Three: Transfer the full balances of TAX and PROFIT to TAX HOLD and PROFIT HOLD at the second bank.
• Step Four: Pay yourself only the biweekly salary you have set from OWNER’S COMP ($500 in the example, leaving $100) and let the rest accumulate.
• Step Five: Pay bills from OPEX ($10,000 of bills against $11,160, leaving $1,160).

If the money cannot cover bills or salary, “this should be a major wake-up call.” He says Profit First did not cause the crisis but made it visible. Even then, keep the rhythm, because money should flow “as a heart pumps blood rhythmically.”

Quarter One (author’s heading)

Quarterly distribution. On the first day (or first business day) of each calendar quarter, tally the PROFIT account without adding that day’s deposits, take 50 percent as the owners’ distribution, and leave 50 percent as reserve. The start date does not matter: whether you begin on July third or September thirtieth, the first distribution is October first. He gives the PROFIT account three purposes: a reward for the equity owners, a metric to measure growth, and an emergency cash reserve.

• A $5,000 balance yields $2,500, divided by ownership percentage among multiple owners.
• Profit is for equity owners and Owner’s Comp is for work in the business. Profit “can never go back to the company,” and terms like “reinvest, plowback, or profit retention” are just “stealing from Peter to pay Paul.”
• Spend the distribution on yourself, on whatever “gives you personal joy.” That is how the cash-eating “Frankenstein” becomes a cash cow.

Pay Uncle Sam. Quarterly tax estimates are paid the same day, softening the sting.

One Small Step. Each quarter, move the CAPs closer to the TAPs. The goal is “to never take a step back,” and he suggests three percentage points a quarter in total, for example Profit 5 to 8 percent, or Tax 11 to 12, Profit 5 to 6 and Owner’s Comp 23 to 24. Percentages should not be undone, which would undermine the habit.

Year One (author’s heading)

At year-end, finalize taxes and compare what is owed with the TAX balance.

• If tax is owed and TAX is short, this is the only time PROFIT may be used for something other than distributions, because “you will go to jail if you don’t pay your taxes.” Then raise the Tax percentage and lower Profit by the same amount.
• If TAX holds too much, move the excess to PROFIT and take a distribution, and perhaps lower the Tax TAP after checking with a financial expert.

Rainy-day fund. Because only half the PROFIT balance is distributed, the rest acts as a reserve, ideally three months of operating cash. Beyond that, excess cash can be a liability (people “like to sue deep pockets”) and should be invested in capital investments that bring growth or used to fund the VAULT account, which is previewed for later.

Profit First Is a Way of Life and Take Action (author’s headings, combined)

Jorge says he will never outgrow the system. The action steps are to start a celebration list for the quarterly distribution and to block the tenth and twenty-fifth on the calendar permanently; the core process takes about five minutes.

Key Concepts and Distinctions

• Day Zero versus Day One: Day Zero is the historical percentage of Real Revenue for each account, and Day One adds 1 percent to Profit, Owner’s Comp and Tax and subtracts 3 percent from OPEX.
• Significance: It makes the starting point objective and painless, so the habit can begin regardless of what the numbers look like.
• No-temptation bank: PROFIT HOLD and TAX HOLD at a second bank, beside the five foundational accounts.
• Significance: Real accounts make allocations visible, and the second bank puts distance between the owner and the money.
• Tenth and twenty-fifth rhythm: A fixed twice-monthly routine of allocating deposits, moving TAX and PROFIT, paying yourself and paying bills.
• Significance: Rhythm replaces reaction, and makes the flow of money visible and bills punctual.
• Quarterly profit distribution: Fifty percent of PROFIT goes to equity owners on the first day of each quarter, and the other half remains as reserve.
• Significance: It rewards ownership and, because it can never be returned to the company, forces the business to run on its operating budget.

Essential Evidence and Examples

• Jorge Morales and José Pain: They began with 2 percent, paid cash for expensive equipment, and later raised their profit allocation to 9 percent on top of their own paychecks. They show that the gradual method works over years.
• Olmec Systems, 1999: The author’s own $1 million business, which paid its partners $40,000 and spent $960,000. It shows what typical Day Zero numbers look like, and how a 1 percent step changes the position.
• Debra Courtright and the bill-paying rhythm: Batching accounting on two dates made the author pay vendors on time every time, supporting the claim that rhythm changes habits, not just books.

Chapter Conclusion and Significance

The chapter concludes that Profit First is installed in small increments and sustained by routine, and that a business that routinely reserves profit, pay and tax first, and pays everything else from what is left, becomes one that serves its owner. The mechanics are purposely modest (a 1 percent increment, a five-minute check twice a month, a quarterly reward) because the habit matters more than the amount.

One tension remains. The starting percentages will often leave the owner short, and the author’s answer is that this is a diagnosis to act on, not a flaw in the system, which depends on cutting expenses and lifting sales to close the gap.

Questions for Reflection

1. Michalowicz argues that starting percentages should be so small that there is “no excuse not to try.” What does this suggest about the real obstacle to financial discipline, and does a 1 percent step produce enough pressure to change behavior?
2. Why might fixed dates and a quarterly distribution change an owner’s decisions more than the same percentages applied irregularly? Which part of the rhythm do you think carries the most weight?
3. He says profit distributions can never go back into the company, even through “reinvest” or “plowback.” What costs does this rule impose in a growing business, and how does the later three-month reserve and VAULT preview soften it?

Chapter 7: Destroy Your Debt

Open in PDF — p. 132 (file not included in this release)

Chapter Objective and Through Line

The chapter argues that an owner in debt should not postpone Profit First until the debt is gone, and should not try to clear the debt by panic. His central image is the crash diet. When “life ‘calls the line,’” owners react with a “narrow, driving focus on the alleviation of immediate pain,” and once the pain eases the action falls away and the old habits return (p. 134 (file not included in this release)). Pete, whose bank called a $1 million line of credit that was fully drawn, stands for the owner who is about to do exactly that.

His answer has two parts. The first is a method, the Debt Freeze: categorize every expense, cut operating costs to 10 percent below the Instant Assessment target, and stop the automatic spending that hides waste. The second is psychology. Pain starts the change, but only pleasure sustains it, so the owner must learn to “get more enjoyment out of saving your money than you do spending your money” (Suze Orman, quoted on p. 135 (file not included in this release)). Profit allocations continue throughout, with 99 percent of each profit distribution going to debt and 1 percent to the owner so that the habit survives.

Chapters 5 and 6 built the allocation system; Chapter 7 shows it works for a heavily indebted business and makes the first systematic attack on expenses.

Chapter Structure at a Glance

1. Crisis reaction is not a cure: crash-diet debt repayment fails because it treats the pain and not the cause, so Profit First must start now, with debt still outstanding.
2. Emotion drives the habit: pain triggers action, but pleasure from saving sustains it, so celebrate every saving.
3. Plan for the worst month: use rolling averages and percentages of real cash, not your best month, to set pay and spending.
4. The Debt Freeze: mark every expense P, R or U, calculate the monthly nut, and cut until operating expenses sit 10 percent below target.
5. Labor and recurring charges are cut hardest: lay off to a leaner team, stop automatic payments, reissue cards, and negotiate the rest.
6. Evidence and momentum: Pete and Jesse Cole show it works, and the Debt Snowball builds emotional momentum for paying off what remains.

Section-by-Section Argument

You Can’t Crash-Diet Your Way Out of Debt (author’s heading)

“Well-dressed poverty is still poverty.” Owners who equate success with top-line revenue dress up the Frankenstein monster, which looks fine until a single fault, such as a big client who does not pay, sets it rampaging. Pete’s story makes this concrete: the bank can call a revolving line “at any time,” and once notified he had thirty days to repay a million dollars, with no cash reserve.

• The weight-loss analogy shows why a reactive rescue fails. People revert once the pain is gone, so the business that survives a crash-diet crisis will probably face another.
• Michalowicz tells Pete to “kill that debt once and for all while still slowly and methodically building profit,” because a business that waits to implement Profit First is “less likely to ever build the business efficiencies that will permanently eradicate your debt” (p. 135 (file not included in this release)).
• The tweak for indebted owners is that when profits are distributed, 99 percent goes to paying down debt and 1 percent rewards the owner. Later, “that 99 percent will go toward building up your cash reserves and your own owner distribution.”

Enjoy Saving More Than You Enjoy Spending (author’s heading)

Suze Orman’s line leads to the section’s claim that “Wealth is a game of emotion.” If spending makes you happy you will spend, whether on pants, a new hire or “new mountains of debt,” and if saving does, you will look for every chance to save. Invoking Anthony Robbins’ pain and pleasure, he says pain gets the ball rolling, such as his daughter sliding her piggy bank to him or Pete’s call from the bank, but “pleasure keeps it moving.” The practical rule is to acknowledge each saving, whether ten dollars or ten thousand, and celebrate it, so the mind learns to equate happiness with choosing to save.

Preparing for Your Worst Month (author’s heading)

Optimistic owners treat their best month as their “new normal” and run the business accordingly. Michalowicz’s guard is to use a twelve-month rolling average and compare each month with the same month last year: “Until your best month becomes your average month, it’s not the norm; it’s the exception.”

• Percentages protect against this because they rest on cash: “Projections are an opinion. Cash is a fact.”
• To set a sustainable owner salary, average the slowest three months of revenue, then apply the Owner’s Comp percentage (his example is 35 percent). Surplus accumulates in OWNER’S COMP, and if the balance cannot cover the salary, you cannot take it and must cut costs. Raise salary quarterly only if the account is accumulating faster than it is drawn down.

The Debt Freeze (author’s heading)

The Debt Freeze commits the business to a rapid pay down of accumulated debt and a freeze on new debt, while continuing Profit First. He is explicit about its limits: “The goal here is to cut cost, not to compromise the business.” Cut the fat, not the muscle.

Print and mark up documents. Gather the last twelve months of the income statement, accounts payable, credit card and loan statements, and payments from all business accounts. Mark every expense, past and present, with one of three letters:

• P: it directly generates (P)rofit.
• R: it is necessary but can be (R)eplaced with a less expensive alternative.
• U: it is (U)nnecessary for delivering your offering.

Everything must be marked, including salaries, commissions, rent, health care and the office Spotify subscription, and doubts should be resolved in favor of “sharpening the pencil.” Then circle every expense that recurs at least once in the next year, since even expenses not incurred lately show what may be coming.

Do the math. Total the year’s expenses, excluding tax payments and owner distributions or salaries, and divide by twelve to get the monthly “nut.” Compare the current monthly operating expenses with the figure from the Instant Assessment (his example is $52,000 against $30,000, a $22,000 cut), and “work a plan” to reach 10 percent below the Operating Expense TAP. Cut U expenses first, then replace R expenses, then restructure P expenses. The extra 10 percent allows for “bounce-back,” when a cut turns out to hurt and must be restored.

Build a leaner team. Labor is typically the most expensive item, and overstaffing is often behind the debt. Owners defend staff with justifications such as “the company will tank without them,” which he calls “super unlikely.” Evaluate each role, not each person, for whether it is mandatory for operations. Those who are not a P must be moved or removed, and the most underutilized employee may be the owner, who must return to doing the work and transition from in to on gradually. The procedure for layoffs is specific:

• Choose a second person as a witness (a partner, HR director or attorney), and with the attorney’s approval explain the reason and offer support you can afford, such as circulating a résumé or some severance.
• Call a staff meeting afterward, take responsibility, and assure the remaining staff they are there to stay.
• “Absolutely do not ask people to take a pay cut.” When he tried it, nearly half the remaining staff began looking for new jobs.

His own layoff of ten of twenty-five employees followed from his mismanaged numbers. He adds that keeping people the company cannot afford risks everyone’s job.

More cuts. Stop all automatic withdrawals except those labeled P, and tell vendors you will pay by check. Ask each credit card company for a new card number and tell it not to transfer old recurring charges, because “your cards have been compromised—by you.” His own forgotten $29 gym membership, which stopped when his card was reissued, shows how small recurring fees hide. Paul Scheiter’s “just one more day” technique gives a delay rule: before buying, go one more day without the item. Sometimes the need disappears, and at least you gain time to find alternatives.

Cut and negotiate. Cut any U expense (“If you doubt whether you can really cut it, cut it. An expense is always easy to add back”). Negotiate every R expense, starting with small ones to build “your negotiation muscle,” researching alternative providers first. Be “informed, firm, and willing to concede so both sides win.” Mark a squiggly line through expenses dropped and a straight line through those reduced, then add up the savings against the 10 percent target.

He ends the section by redefining success as “the most profit, generated through the fewest employees and with the least expensive office space,” moving from “make a lot” to “save a lot.”

If You Owe the Bank a Million Dollars (author’s heading)

Pete opened a PROFIT account, cut expenses, and called the bank. The banking saying runs, “If you owe the bank a thousand dollars, it’s your problem. If you owe the bank a million dollars, it’s their problem,” and the bank agreed to a payment plan. Within three months he had paid 5 percent of the debt and turned a profit.

• Jesse Cole, owner of the Savannah Bananas and Gastonia Grizzlies, used Profit First to pay down more than a million dollars of debt taken on over two years, expecting to be debt free in two years.
• His argument is that “The only way to get out of debt is by being profitable,” because debt accumulates when expenses exceed cash, and only profit reverses that.
• Debt pressure also produces “innovation by necessity.” Cole replaced a roughly $30,000-a-season ticketing system with a hundred thousand banana-shaped printed tickets for $6,000, which also serve as souvenirs (p. 148 (file not included in this release)).

Least Effort, Biggest Results (author’s heading)

Momentum “builds slowly but relentlessly” through small repeated actions. Michalowicz endorses Dave Ramsey’s Debt Snowball: list debts from smallest to largest regardless of interest rate, pay minimums on all but the smallest, and attack the smallest with everything available. When it is gone, roll its payment into the next one. Ramsey’s logic is emotional, because tearing up a paid-off statement builds the drive for the next. The snowball only works if “you cannot add new debt as you pay off old,” which is why the Debt Freeze comes first.

Take Action: Down with Debt! (author’s heading)

• Step 1: Start the Debt Freeze and get the monthly nut to 10 percent lower than the Instant Assessment suggests.
• Step 2: Use 99 percent of the profit allocation to wipe out debt, keeping 1 percent for celebration.
• Step 3: Start the Debt Snowball, paying the smallest debt first and using freed-up payments for the next.

Key Concepts and Distinctions

• Crash-diet reaction versus permanent habit: A reactive blitz on debt relieves pain without changing behavior; the Profit First habit changes it.
• Significance: It explains why Profit First must start while the debt remains.
• P, R and U expenses: Expenses that generate profit, can be replaced with cheaper alternatives, or are unnecessary for delivering the offering.
• Significance: The triage gives a defensible order of cuts (U first, then R, then P) that protects the muscle.
• Monthly nut and the 10 percent margin: The monthly total of necessary expenses, cut to 10 percent below the operating expense TAP.
• Significance: The margin absorbs “bounce-back.”
• Cash is a fact, projections are an opinion: Percentages apply to deposited cash and rolling averages replace best-month thinking.
• Significance: It prevents spending against income not yet received.
• Debt Snowball: Smallest-debt-first repayment with freed payments rolled forward.
• Significance: It prioritizes emotional momentum over interest-rate logic, matching the chapter’s pain and pleasure theme.

Chapter Conclusion and Significance

The chapter concludes that debt is a symptom of spending beyond cash, so it can only be solved by profit, discipline and a changed relationship to money. The Debt Freeze sets the expense floor, the 99/1 split keeps the habit alive, and the Snowball and celebration supply the motivation pain alone cannot.

A tension remains: the claims that cuts are bearable rest largely on his own experience and anecdotes (Pete’s results are described only as “massive”), and the 10 percent and 99 percent rules are his own conventions, not derived from evidence in the chapter.

Questions for Reflection

1. Michalowicz says pain starts change and pleasure sustains it. Is the advice to celebrate each saving enough to counter the pull of spending, and what might make it fail?
2. The P, R and U categories depend on judgment, and he admits they get “very subjective.” How would you test a borderline expense, and what does the 10 percent bounce-back margin imply about how much error he expects?
3. He recommends the Debt Snowball over paying the highest interest first. When is emotional momentum a stronger argument than arithmetic, and when might it cost real money?

Chapter 8: Find Money within Your Business

Open in PDF — p. 151 (file not included in this release)

Chapter Objective and Through Line

The chapter opens with a flat claim: “Your company has more money than you realize. You just don’t know where to find it. Yet.” Michalowicz argues that profit comes mainly from efficiency, not from more sales, and that the cash needed to fund the allocations from Chapter 6 is already inside the business. The opening story of “Mr. Innovator,” who asked how to keep doing what the company did for one third of the cost and so “split the truck” into a tank side and a shelf side, grew a struggling company into a $50 million one by nearly halving expenses.

The main problem is the top-line habit of hiring a “rainmaker” and selling more. Without efficiencies in place, new revenue brings matching costs “likely to go unchecked.” Against this he sets the water image of the chapter title: it is smarter to dig a well than to make it rain, because “95 percent of your company’s profitability is contingent on what goes on beneath the surface (after the sales).” The argument develops from why profit gets squeezed, through a method for efficiency (a massive goal, “two times the results with half the effort”), to client selection, where the same logic is applied to who you serve and what you sell.

In the book’s progression, Chapter 7 cut expenses to survive debt. This chapter turns cost-cutting into a permanent source of profit, and sets up the later return to selling, which he says should come after efficiency.

Chapter Structure at a Glance

1. Innovation under a cost target finds hidden money: a hard constraint forces a better question.
2. Efficiency before sales: extra revenue without efficiency only multiplies unchecked costs.
3. Profit is squeezed by competitors: high margins attract imitation and price cuts, so the owner must keep innovating.
4. Set a massive efficiency goal: double the results with half the effort, using big questions, and chip away at expenses if the full cut cannot be made at once.
5. Apply efficiency to the client base: fire unprofitable clients, clone the best ones, and overlap clients with profitable offerings.
6. Sell smart: narrow the offering and avoid the upsell trap, and use the closing action steps.

Section-by-Section Argument

It’s Smarter to Dig a Well Than Make It Rain (author’s heading)

“Rainmaker” fantasies, in which a salesperson saves the day with big sales, hold companies back, because owners are already the “ultimate rainmakers” and the real problem is cost. Focusing on sales alone is like putting out rain barrels and dancing “while ignoring a massive water source beneath your feet.”

• The Idaho example: with limited rainfall, 95 percent of the state’s water comes from underground.
• The parallel is that “95 percent of your company’s profitability” depends on what happens after the sales.

The Profit Squeeze (author’s heading)

Greg Crabtree, author of Simple Numbers, Straight Talk, Big Profits!, answers Michalowicz’s question about whether there is too much profit: “You always want to expand profit … In fact, you must,” because competition continually takes it away. When someone finds a big leap in profitability, rivals “sniff it out,” someone drops prices, and everyone else has to follow. This is “how profits get squeezed” (p. 154 (file not included in this release)).

• Flat-panel televisions illustrate the cycle: prices fell 25 percent a year from around 2005, profits jumped briefly as manufacturing got easier, and then price cutting returned.
• He adds that margins above about 20 percent get copied almost immediately, so “even if you think you’re good with profit, you’re not.”
• A fixed profit allocation percentage forces innovation: when prices drop and the allocation “feels the squeeze,” it is time to innovate again.

Two Times the Results with Half the Effort (author’s heading)

More sales without efficiency “lead to further inefficiency,” so “more sales make you less profitable.” He asks the owner to slow or halt selling while building efficiency, using the toothpaste analogy: think of switching to a travel-size tube and making it last through frugality (using conservatively) and innovation (twisting, turning and squeezing ideas). The sequence is efficiency first, then selling more, then more efficiency, and then more selling, until the two happen simultaneously.

His definition of efficiency is broad: serve the same type of great clients with similar problems, and perfect repeatable solutions. The McDonald’s example shows “the fewest things you can do repetitively to serve a consistent core customer need.”

The goal is stated as a question: “How do you get two times the results with half the effort?” Effort is “financial cost and time cost.” His example is a snowplower who plows one lot per hour and needs to plow two in thirty minutes.

• Resistance usually comes from fear and from “let the other guy figure it out” thinking, when “the other guy will figure it out.”
• At Hedgehog Leatherworks, Profit First removed the ability to buy traditional expensive equipment, forcing hundreds of innovations at “1/100th the cost” of industry standards (p. 157 (file not included in this release)).
• Small questions yield small answers. Cutting five minutes from a task will not matter, but a plow that moves snow twice as fast amplifies with every new account: “That is the power of percentages.”
• UPS asked the efficiency question and found savings in right turns (about $6 million a year), keys carried on the pinky, and washing trucks every two days instead of daily. His point is that you may be missing your own “efficiency miracle.”

Chip Away at Expenses (author’s heading)

Wesley Rocha of LinkUSystems went ten years without a raise because expenses ate every increase. He could not immediately cut without damaging the business, so he reduced costs gradually: six employees left, unprofitable products were dropped, processes were optimized, and each project now has an allowable expense before it is taken on. In the first year his profits doubled, and his income rose about 46 percent between salary and disbursements, enabling a house down payment. The lesson: “You don’t have to slash and burn the moment you put down this book. You can take it slow. Just get started.”

Fire Bad Clients (author’s heading)

Letting go of clients who “suck us dry” is efficiency applied to the customer base, a theme from his earlier book The Pumpkin Plan. A Strategex study of a thousand companies sorted each firm’s clients into quartiles by revenue:

• The top quartile produced 89 percent of revenue, and the bottom quartile 1 percent.
• Each quartile required about the same effort and cost.
• The top quartile produced 150 percent of profit, the middle two broke even, and the bottom quartile lost 50 percent (p. 161 (file not included in this release)).

So top clients subsidize the worst. He says dropping the worst unprofitable clients and their costs produces a profit jump and less stress, often within a few weeks. “All revenue is not the same.” Because it is scary when payroll is due, he advises starting small by dropping “one rotten little pumpkin,” which frees time and attention for an ideal client.

Clone Your Best Clients (author’s heading)

Imagine your favorite client with five, ten or a hundred identical twin companies. Having clients with similar needs makes you:

• Superefficient, because you serve few but consistent needs.
• Better at service, since “we cater to the people we care about.”
• Self-marketing, because best clients associate with others like them and talk you up.

Clones “are the very definition of efficiency, which is why they are like gold.”

The Pareto Overlap (author’s heading)

The Pareto Principle says 20 percent of clients yield 80 percent of revenue and 80 percent of profit derives from 20 percent of offerings. The advanced step is to connect the two, and “Once you see the overlap, the decisions become very easy”:

• Get rid of the “bad” clients who only want your least profitable products and services.
• Find a new way to manage weak clients who do buy profitable offerings, since meeting to set new expectations and communication methods can improve them.
• Meet with top clients who do not buy profitable offerings to find how to deliver profitable ones.

Cutting the cost of serving weak clients and freeing time for the ones you love makes the technique do “double duty.”

Sell Smart (author’s heading)

Ernie, the author’s lawn guy, upsold gutter cleaning, then roof repairs, ending the day with $1,500 in revenue but about $2,000 spent on tools, supplies and labor, and had to redo the lawn. As variety grows, specialized equipment sits unused and the owner lands in the Survival Trap. Shawn, who charges the same $200 to clean leaves, did four more properties that day and solicited two more. “Shawn has achieved efficiency,” and sees it as “getting more of the same things done with better and better results, using fewer and fewer resources.”

His conclusion: selling more is the hardest way to raise profit, because at best “the percentages stay the same” and more commonly expenses grow faster than sales. Efficiency applied to the top line (fire bad clients, clone good ones, refine the offering, then sell smart) is the “surefire way” to profitability.

Take Action: Let Go of Dead Weight (author’s heading)

• Step 1: Take one aspect of the business that benefits your best customers and find how to get two times the results for half the effort.
• Step 2: Using the chapter’s parameters, identify the weakest clients and fire them politely, without burning bridges.

Key Concepts and Distinctions

• Dig a well versus make it rain: Profit comes from the efficiencies beneath the surface, not from sales activity above it.
• Significance: It reverses the top-line habit and tells the owner where to look for cash.
• The profit squeeze: Competitors copy high margins and cut prices until the margin disappears.
• Significance: It makes constant innovation a requirement, and explains why a fixed profit allocation is useful.
• Two times the results with half the effort: A deliberately large efficiency goal measured in financial and time cost.
• Significance: Big questions produce both incremental and landslide improvements, which percentages then amplify as sales grow.
• Client quartiles and the Pareto Overlap: Revenue and profit are concentrated in few clients and offerings, so they must be analyzed together.
• Significance: It turns the choice of whom to serve into a profit technique.
• Cloning best clients: Targeting more clients like the best one.
• Significance: It builds efficiency, better service and automatic marketing at once.

Chapter Conclusion and Significance

The chapter concludes that the way to find money is to attack inefficiency in every layer, from trucks and keys to clients and product lines, and that growth should follow efficiency, not precede it. Percentages make the effort pay twice, since every improvement carries into each new sale.

The evidence is mostly anecdote and the author’s own experience, with the Strategex study as the one cited dataset (he gives no further detail on it). The advice also pulls two ways: slowing or halting sales while looking for efficiency, and firing clients even while payroll is tight, carry real risk, which he answers only by recommending small first steps.

Questions for Reflection

1. Michalowicz says to halt or slow selling until efficiency is in place. In what circumstances would that advice be sound, and when would it endanger a business that cannot afford it?
2. The Strategex quartile findings imply that most clients are unprofitable to serve. How would you check your own client base for that pattern, and what other costs of dropping a client might the analysis omit?
3. The “two times the results with half the effort” goal depends on asking big questions. How does the profit allocation percentage create the pressure that produces those questions, and could the same pressure produce harmful cuts?

Chapter 9: Profit First—Advanced Techniques

Open in PDF — p. 166 (file not included in this release)

Chapter Objective and Through Line

Michalowicz argues that once the core system is working, customization is simple and follows one rule, voiced by his colleague Erin Moger at a ProfitCON Q&A: “When in doubt add an account.” A business with seasonal swings, large periodic outlays, reimbursements or prepaid work does not need a different system. It needs more accounts layered onto the five foundational ones (INCOME, PROFIT, OWNER’S COMP, TAX, OPEX) and the two no-temptation accounts in a separate bank (PROFIT HOLD, TAX HOLD).

The chapter is explicitly gated. He compares it to training for a marathon and tells readers not to implement any of it until they have completed at least two full quarters (180 days, plus) of the core practice. The test is four honest yeses: biweekly allocations are being made, some profit has accumulated, a few profit distributions have been taken, and some form of accountability is in place.

The additions all serve one end: a clear, accurate picture of how much is available for a specific purpose, so decisions are made against real balances. The chapter then turns from accounts to the numbers that run them: the Required Income for Allocation, an employee-count ratio, and a handful of low-effort behavioral tactics. It extends the book’s central design principle, which is to make the right behavior the easy one at the bank.

Chapter Structure at a Glance

1. Earn the right to advance: complete two full quarters of the core system, with four checks, before adding anything.
2. Add accounts to match the business: each extra account isolates money with one purpose, which simplifies decisions.
3. Document the process: a one-page description of every account and every transfer, so the system survives forgetfulness and handover.
4. Replace the monthly nut with the RIFA: compute the deposit needed at each allocation date from the owner’s required pay.
5. Handle outside money carefully: raise capital only when already profitable, and ring-fence it in its own account.
6. Use ratios and small tactics: Real Revenue per employee, then behavioral tricks that put friction in front of temptation.

Section-by-Section Argument

Advanced Simplification (author’s heading)

The claim is that more accounts make the system simpler, because each balance answers one question. Michalowicz began adding them a few years after adopting Profit First himself, when reimbursements, up-front client payments and big purchases forced him back into accounting work. His recommended additional accounts, each “contingent on your business needs,” are below. Nicknames are up to the owner (he calls the pass-through account REIMBURSEMENT).

• The Vault: an ultra-low-risk, interest-bearing account for short-term emergencies. Every business should hold a three-month reserve, enough to cover all costs if not a single sale came in. Rules for its use must be written in advance, for example cutting all related costs within two months if the drawdown was caused by falling sales. Its purpose “is not to buy time” but to force decisions early, before a cash crisis returns the business to the Survival Trap. p. 168 (file not included in this release)
• Stocking: for inventory and big purchases, funded in equal slices at each tenth and twenty-fifth allocation.
• Pass-Through (Reimbursement): a checking account for income that is not the business’s own, such as client reimbursements of travel. It bypasses INCOME, then goes to the vendor or back to OPEX if the bill was already paid.
• Materials and Contractors/Commissions: for businesses whose revenue mostly flows through to costs. Money here is never allocated to anything else; leftover at quarter’s end moves to INCOME. Use both if both apply.
• Employee Payroll: fund it from INCOME (advanced Profit First) or from OPEX (basic) every tenth and twenty-fifth, covering gross pay plus payroll taxes, and point the payroll service at this account.
• Equipment: estimate the future purchase, divide by the months available to save, halve that, and allocate it at each tenth and twenty-fifth.
• Drip: for retainers and prepayments. The whole payment is deposited, untouched, and a fixed portion is transferred to INCOME on schedule (for $120,000 covering a year, $10,000 a month, or $5,000 each on the tenth and twenty-fifth). Its value is showing the true cash flow of earned money.
• Petty Cash: a separate account with a debit card, funded by a fixed amount from OPEX (he allocates $100 every two weeks). “If it’s not in my PETTY CASH account, it ain’t in my budget.”
• Prepayment: for taking discounts on services paid in advance.
• Sales Tax: every penny of sales tax collected moves out of INCOME first, before the allocations are run on the rest. On a $100 sale at 5 percent, deposit $105, move $5, then allocate the $100. It is not the owner’s money.

His own setup (Fig. 6) shows the pattern: Bank 1 holds INCOME, PROFIT 15 percent (target 18), OWNER’S COMP 31 percent (target 32), TAX 15 percent, OPEX 39 percent (target 35), plus PETTY CASH at a fixed $75, EMPLOYEE PAY at a fixed $1,500, REIMBURSEMENT and DRIP at 0 percent. Bank 2 holds PROFIT HOLD, TAX HOLD and the Vault. He writes the current percentage or dollar amount, and the TAP in parentheses, beside each name.

Write Down the Process (author’s heading)

The system should be documented in a single page defining each account’s purpose and the sequence: on the tenth and twenty-fifth, INCOME is distributed to PROFIT, OWNER’S COMP, TAX and OPEX by percentage; the fixed dollar amounts ($75, $1,500) move from OPEX; then the full balances of Bank 1’s PROFIT and TAX move to Bank 2. It lets a bookkeeper take over and guards against forgetting the rules.

Shift Your Focus from the “Monthly Nut” (author’s heading)

The monthly nut is a leftover of the GAAP mindset and focuses on expenses, which keeps the owner in the Survival Trap. “You get what you focus on.” The replacement is the Required Income for Allocation (RIFA), the deposit needed by the tenth and again by the twenty-fifth. The method, taught by his partner, is:

• Take monthly required personal income and divide by two (paid twice a month), then divide by the Owner’s Comp percentage.
• In his example: $5,000 divided by 0.31 gives just over $16,000 per allocation date.
• With twenty-four allocations a year, that annualizes to $384,000 of business income.
• Compared with the $13,432.23 in his INCOME account, he is about $3,000 short and needs to keep sales moving. His DRIP balance does not rescue him; it contributes only about $1,000 per allocation period.

With multiple owners, add all owners’ pay first: two owners at $10,000 each means $20,000 a month, halved, divided by 0.31, for a RIFA above $32,000. p. 176 (file not included in this release)

Why PROFIT and TAX Are $0.00 at Bank 1 (author’s heading)

Those accounts are a “holding tray for a day or two.” Money is allocated and the same day swept in full to the Bank 2 hold accounts, removing the temptation immediately. Profit accumulates in PROFIT HOLD, and the quarterly distribution is 50 percent of that balance (his example: $14,812.11 times 50 percent, over $7,000). He also advises turning off any bank “grand total,” since seeing everything on one plate again defeats the system.

Raising Capital and Affording a New Employee (author’s headings)

On outside money he is cautious: raising is risky and he generally discourages it unless profitability is already established, because only then do you know what to amplify. If you do raise, open an OUTSIDE CAPITAL account, spend it only as agreed with the investor, and renegotiate the plan if circumstances change. The same applies to loans.

For hiring, he offers a ballpark: each full-time employee should be matched by $150,000 to $250,000 of Real Revenue (not top line), ideally more, so a million-dollar company supports four to six people including the owner. Efficiency is the goal, not the relative who needs a job. Citing Greg Crabtree, Real Revenue should be 2.5 times total labor cost in a tech business and four times in a cheap-labor field. On $6,000,000 of Real Revenue that caps labor at $1,500,000 (cheap labor) or $2,400,000 (expensive labor).

Mini Power Tactics (author’s heading)

Each is a small behavioral barrier or reminder.

• The Government’s Money: move the TAX account to a third-party bank you don’t see and rename it THE GOVERNMENT’S MONEY, so borrowing from it feels like stealing.
• Hide Accounts: hide every account except OPEX if the bank allows it.
• Outside Income Accounts: PayPal, wire and similar accounts sweep into INCOME daily (or at each allocation), because they are revenue, not extra.
• Account Snapshot: automated balance alerts for INCOME and OPEX on the tenth, fifteenth, twenty-fourth and thirtieth, and a daily PETTY CASH alert.
• Bank Checks: pay with bank checks so the money leaves immediately; the lost float is about five dollars a year for most small firms.

The Take Action step: put one advanced tactic on the to-do list six months out.

Key Concepts and Distinctions

• Mo’s rule (“add an account”): Customization is done by adding purpose-specific accounts rather than redesigning the system.
• Significance: It marks the line between a basic and an advanced user and keeps all extensions in the same bank-balance logic.
• Real Revenue versus pass-through money: Reimbursements, materials and subcontractor money are not allocated to Profit or Owner’s Comp.
• Significance: Allocating percentages on pass-through money would distort pay and profit, so separate accounts keep the allocations honest.
• Required Income for Allocation (RIFA): The deposit needed at each allocation date, equal to half of monthly required owner pay divided by the Owner’s Comp percentage.
• Significance: It converts the system into a sales minimum and replaces the expense-centered monthly nut.
• Holding tray: A Bank 1 account that only passes money to Bank 2 the same day.
• Significance: Allocation happens in the daily-use bank while the money leaves sight.

Essential Evidence and Examples

• JB’s RoofDeck Solutions: His supplier requires a $5,000 minimum order every ten months, so he allocates one-twentieth ($250) at each tenth and twenty-fifth. This shows how slicing a lumpy bill turns a scramble into a barely felt habit.
• TravelQuest International: Customers book trips up to five years ahead while most costs fall in the year of the trip. Their DRIP account shows why prepaid revenue must be released gradually rather than treated as income on arrival.
• TSheets: The cofounder raised $15 million, then waited until the right use arose to amplify what was already working. It illustrates the principle of becoming profitable first and raising capital second.

Chapter Conclusion and Significance

The chapter shows that Profit First scales by repetition of a single mechanism: separate accounts, fixed allocation dates, and balances visible where decisions are made. Each added account makes one future obligation visible, whether it is a bulk order, a payroll, a prepaid year or a government tax claim. The RIFA completes the picture by telling the owner what sales level the allocations require.

The qualification is sequencing. The author insists the material is for those who have already proven the core habits, and he calls the employee ratios a ballpark rather than an exact system. Several tactics depend on what a bank allows, so they are options rather than requirements.

Questions for Reflection

1. Why does Michalowicz require two quarters of core practice before advanced techniques, and what failure would he expect if a reader skipped that gate?
2. How does replacing the monthly nut with the RIFA change what an owner does when the INCOME balance is short on the tenth?
3. Several mini tactics rely on making money harder to see or reach. What assumption about owner behavior underlies them, and where might that assumption fail?

Chapter 10: The Profit First Life

Open in PDF — p. 182 (file not included in this release)

Chapter Objective and Through Line

Michalowicz extends the system from the company to the household. His case is that an owner’s personal finances are “in lockstep” with the business, and he replaces the usual “child” analogy with a better one: the business is a conjoined twin, and separating from it takes surgical precision. Everything already learned (pull money out before spending, use small plates, remove temptation, automate on the tenth and twenty-fifth) applies to a life that also has variable income, crises and a vision.

The chapter opens with a reframing of budgeting. Jorge, the owner of Specialized ECU Repair, repeats his mother’s line that “When you make enough money, you don’t have to budget.” Michalowicz reads this as: Profit First applies good restrictions to the business, and once the profit distribution arrives the restrictions come off, within reason. Laurie Dutcher shows the same pattern: after she began paying herself and putting profit first, her first quarterly distribution took her family to Disneyland, and her business grew faster.

The chapter then gives a personal Profit First procedure and a set of behavioral controls: a debt freeze, a four-step personal setup, a quarterly debt-payoff ritual, a lifestyle lock, and a children’s version. The stated goal is financial freedom, “doing what you choose to do whenever you choose to do it,” reached when saved money yields enough to support the lifestyle and keeps growing.

Chapter Structure at a Glance

1. Restriction before reward: profit discipline in the business is what permits spending without anxiety once distributions arrive.
2. Treat personal money as a business: the owner’s finances and the company’s are linked, so the same system is applied to both.
3. Face the debt and set up personal small plates: a fixed order of steps, then accounts for income, emergencies, bills, daily spending and debt.
4. Cut decisively and celebrate in a set order: loss aversion explains slow cutting, and distributions are split by rule between debt and reward.
5. Lock the lifestyle: Parkinson’s Law is countered with five years of fixed living standards, or the Wedge as plan B.
6. Teach it to children: an envelope system that builds earning, saving and giving habits.

Section-by-Section Argument

The Profit First Lifestyle (author’s heading)

Financial freedom is the aim and it changes shape over time: Jorge and José’s early distributions funded travel, later one helped a spouse through law school and the other renovated a house. The claim is that the road to it is “paved with simple, small habit changes” applied to business and personal finance alike. He does not offer a family budget or 401(k) advice; he applies the book’s logic. The numbered steps follow. p. 185 (file not included in this release)

• Step 1, face the music: add up all monthly bills, annual bills and debt.
• Step 2, freeze debt: if there is any debt, stop accruing more and put a freeze on all purchases that cannot be paid with cash.
• Step 3, set up a personal Profit First habit: an automatic withdrawal on each pay date (the tenth and twenty-fifth) to a retirement savings account. While any debt remains, keep the percentage at 1 percent and use every other penny after necessary expenses to eradicate the debt.
• Step 4, set up the “small plates”: five foundational personal accounts plus Big Event accounts, described next.

The five personal accounts (analytical division within Step 4)

• INCOME: where deposits land; allocations come out of it and nothing else.
• The VAULT: initially the “oh shit” account, the savings needed to get through a month when something dire happens. Suze Orman recommends eight months of living expenses, but a good starting balance is one month’s rent or mortgage payment. It must be hard to reach (different bank, no online banking, no checkbook). Once debt is gone it grows and becomes a source of income.
• RECURRING PAYMENTS: for fixed bills (mortgage, car loan), varying bills (utilities) and short-term bills (installments). Transfer monthly the fixed total, plus the monthly average of the varying bills plus 10 percent, plus the short-term total.
• DAY-TO-DAY: one for each person who pays everyday costs, funded from INCOME on the tenth and twenty-fifth by spending requirements, each with a debit card so purchases deduct immediately.
• DEBT DESTROYER: receives all remaining funds. Following Dave Ramsey, pay the minimum on each debt, then pay the smallest debt first regardless of interest rate unless rates are extreme, because the win builds momentum: “we are emotional beasts, not logical ones.”
• Big Events: home, cars, weddings and college. He suggests programs such as 529 plans and says these accounts are optional ideas.

Credit cards: the emergency line (analytical division)

If in debt, cut up the credit cards. His one exception reflects irregular entrepreneurial income: keep a single card as a buffer for dark months, in a sealed envelope marked “Emergency Only,” held by a trusted friend. Then add a guardrail. Each quarter, ask the issuer to cut the limit by 50 percent of the amount paid down. If a 0,000 card is paid down by ,000, the limit drops by ,500 to ,500. Repeat until the balance is zero and the limit is ,000. He dismisses the objection that lower limits hurt credit scores: the goal is to remove stress, and scores can wait until the debt is gone.

Rip Off the Band-Aid (author’s heading)

The author explains why people cut slowly. His own turning point came when his daughter handed over her piggy bank to help in his self-made crisis, while he still kept three luxury cars and a country-club membership. People “dole out the pain in small increments” because of loss aversion and the endowment effect: we value what we own more than an identical thing we do not, as with a red Porsche that has become “your baby.” He instead cut everything at once, down to two used basic cars, and found that no one else cared. The recommended response is to cut all unaffordable expenses at once. p. 189 (file not included in this release)

Death to Debt (author’s heading)

The quarterly distribution is divided by rule, and the debt payment comes first and is celebrated.

• While the owner has core debt (credit cards, bank loans, student loans): put 99 percent toward debt, smallest first, immediately by debit card, and keep 1 percent as a real reward such as dinner or ice cream.
• Once core debt is eradicated: 45 percent to extra payments on remaining long-term debt (beyond the normal mortgage or car payments) and 55 percent for a splurge. He argues the larger share is psychologically more satisfying.
• Once cars and home are owned outright and debt is gone everywhere: 100 percent of the distribution goes to the owner.

He insists rewards are essential: debt reduction relieves pain but gives little pleasure, and doing both packs more punch.

Lock In Your Lifestyle (author’s heading)

Parkinson’s Law says that with ten dollars in your pocket you will spend ten. Because Profit First will make things much better, the risk is expanding spending to match. He asks for five years of living at the lifestyle designed now, with no new cars, brand-new furniture or “crazy vacations,” so that a wide gap between earnings and spending accumulates until money earns more each year than is spent in a year. Five rules keep it in place:

1. Always start by looking for a free option.
2. Never buy new when used gives the same benefit.
3. Never pay full price if it can be avoided.
4. Negotiate and seek alternatives first.
5. Delay major purchases until ten alternatives have been written down and considered, and save splurging for quarterly distributions.

Frugal is not cheap: it removes stress so that the things bought are enjoyed.

Plan B, and the next step after five years, is the Wedge (credited to Brian Tracy as far as he can tell): upgrade the lifestyle gradually by setting aside half of every income increase. Starting from take-home of $100,000 with $20,000 saved and $80,000 spent, a rise to $135,000 sends 50 percent of the $35,000 increase ($17,500) into the Vault, and the owner still saves 20 percent of what remains. p. 193 (file not included in this release)

Profit First Kids (author’s heading)

Instead of an allowance he uses a posted job list with pay rates, so children learn that money is earned and lose any sense of entitlement. Each child labels five envelopes, and the golden rule applies: allocate before doing anything else.

• Big dream: up to 25 percent of earnings.
• Family support: a recurring, age-appropriate amount (for example five dollars a week) so that paying out regularly becomes normal.
• Impact: 5 to 10 percent, for charity or something meaningful such as starting a business.
• Vault: 10 percent, for emergencies and later investing.
• Mad money: the rest, for whatever they want.

The Take Action steps are to set up personal allocation accounts, work out what to live on under the lifestyle lock, and sit down with the family to talk numbers.

Key Concepts and Distinctions

• Financial freedom: Doing what you choose whenever you choose, reached when saved money yields more each year than you spend.
• Significance: It is the stated end point of personal Profit First and the reason for building a gap between income and spending.
• Loss aversion and the endowment effect: We overweight losses and overvalue what we own, so we cut slowly and cling to things.
• Significance: They justify cutting everything at once rather than in increments.
• Lifestyle lock versus the Wedge: The lock freezes the standard of living for five years; the Wedge allows gradual upgrades by banking half of each increase.
• Significance: Both counter Parkinson’s Law, one strictly and one gently.
• Debt snowball in the Profit First setting: Smallest debt first for momentum, paired with a rewarded split of distributions.
• Significance: It treats debt payoff as emotional as well as arithmetic.

Chapter Conclusion and Significance

Michalowicz concludes that personal and business finance are one problem solved with one habit: allocate first, keep the reserve out of reach, and let a simple rule rather than willpower govern each payout. The distribution rules (99/1, then 45/55, then 100 percent) tie the business’s profit directly to the owner’s debt-free life, so the system rewards the behavior it demands.

The tension is that the approach is deliberately frugal and rule-heavy while claiming to free people from budgeting. His resolution is that restriction precedes reward and that frugality reduces stress. Some prescriptions, such as ignoring credit scores, are offered as judgments of priority rather than as universal financial advice, and he states plainly that he did not write the book to teach family budgeting.

Questions for Reflection

1. Jorge says that when you make enough money, you don’t have to budget. In what sense does Profit First replace a budget rather than abolish it?
2. Which of the chapter’s rules depend on psychology (loss aversion, momentum, Parkinson’s Law) rather than arithmetic, and what would be lost if the arithmetic-optimal order were used instead?
3. How do the lifestyle lock and the Wedge differ in cost and risk, and for what kind of owner would each fail?

Chapter 11: How to Keep It from Falling Apart

Open in PDF — p. 197 (file not included in this release)

Chapter Objective and Through Line

The chapter’s thesis is blunt: “The worst enemy of Profit First is you.” The system is simple, but most owners fail at the discipline of applying it consistently. They half-do the debt freeze, refuse to cut staffing or office costs, and steal from themselves by taking allocated profit to pay bills or pulling from the TAX account to pay salaries. The single biggest reason the system falls apart, he says, is that “we go it alone.”

His remedy is accountability, illustrated by a story from his friend Anjanette Harper’s winter camp in Minnesota. Campers weighed their plate scrapings, were told to cut waste to a few ounces per meal by week’s end, and reached zero by watching one another’s portions, passing leftovers and nudging each other. Going it alone is Mistake #1. The rest of the chapter catalogs seven more mistakes, each with the behavior that causes it and the corrective rule, and ends by recommending a Profit First Professional.

Within the book, this is the maintenance chapter. The earlier chapters supply the mechanism; this one explains why the mechanism fails in human hands and applies the same principle as the rest of the system: design the environment so that the easy action is the right one.

Chapter Structure at a Glance

1. The enemy is the owner: discipline fails most when owners work without anyone to answer to.
2. Accountability solves the biggest failure: a buddy or group raises follow-through.
3. Pace and percentages: starting too high on profit, or choosing growth over profit, defeats the system.
4. Spend logic: cut costs that do not build efficiency, and never “plow back” or borrow from allocation accounts.
5. Taxes and complexity: the TAX account must be left alone, and the system must not be made harder than it is.
6. Put it in the bank and get help: the system must live in the accounts where decisions are made, with a professional if needed.

Section-by-Section Argument

Mistake #1: Going it alone (analytical division; the author names it Mistake #1 in the text)

Accountability works, according to the author, for four reasons: persistence rises because someone depends on you (and friendly competition helps); painful processes shrink when shared; enforcing a plan with another person makes you more likely to do your part; and regular meetings create a rhythm that breaks big goals into milestones. It is the foundation for the remaining mistakes because every later one is easier to commit in private. p. 199 (file not included in this release)

Mistake #2: Too much too soon (author’s heading)

New users often put 20 or 30 percent into PROFIT, find they cannot afford it, and pull the money back to pay bills, which “defeats the entire process.” Profit First works backward from the goal, so efficiency has to arrive to support the profit. The rule: start with a small percentage to build the habit, then move allocation percentages closer to the goal by an additional 1 or 2 percent every quarter.

• Jorge and José set 20 percent, found it could not coexist with their growth, and settled on 9 percent.
• Their strategy is constant innovation backed by paying employees 30 percent more than the industry norm, and they stay “wildly profitable.” The lesson is to identify what supports profit, commit to it, and drop what does not.

Mistake #3: Grow first and profit later (author’s heading)

The common objection, “I want to grow my company,” rests on the myth that profit and growth are a trade-off. The author argues they “go hand in hand”: the healthiest companies are profitable first and then grow that. The grow-at-all-costs model is survivorship bias, since the few lottery-winner companies are visible and the many destroyed ones are not (selection bias). His main example is Twitter, which after ten years of business had lost $2 billion since 2011 with no profit. Mark Cuban’s stimulus plan requires an investee to be profitable within ninety days, and the author’s own position is stricter: profitable starting today. p. 202 (file not included in this release)

Mistake #4: Cutting the wrong costs (author’s heading)

Assets are defined as expenses that bring more efficiency, meaning more results at lower cost per result. In his example, a knife maker proud of keeping 1960s equipment produced inconsistent knives, while a competitor produced perfect knives at four times the volume per hour. The rule: if a purchase will raise the bottom line through significant efficiency, find savings elsewhere or consider discounted equipment, but do not sacrifice efficiency.

Mistake #5: “Plowing back” and “reinvesting” (author’s heading)

Plowback and reinvest are “other ways to say borrow.” If OPEX cannot cover expenses, the usual cause is that expenses are too high. Less often, Profit or Owner’s Comp percentages were started higher than the business can sustain. Credit cards are not lines of credit or bridge loans; using them to cover what you cannot afford is a red flag and creates debt. Reserve cards for true emergencies or purchases that yield income. “You need to invest thought, not reinvest money.”

Mistake #6: Raiding the tax account (author’s heading)

The temptation arises when allocations exceed the accountant’s estimates. In his example, estimates of $5,000 a quarter against about $8,000 reserved leads to a $3,000 withdrawal. Estimates are based on the prior year’s income, and higher profit means higher taxes, so a growing TAX balance is likely to be needed, and paying more tax signals improving health. His own mistake was increasing Owner’s Comp with the surplus. The rule is to talk quarterly with an accountant who specializes in both profit maximization and tax minimization, and never to take money from the TAX account.

A second tax issue is “paying for your sins”: charges, interest and card fees can be expensed, but payments that pay down debt cannot. As the owner becomes profitable and pays off debt, taxes are due on that income, which feels like a double whammy but is not. p. 205 (file not included in this release)

Mistakes #7 and #8: Adding complexity and skipping the bank accounts (author’s headings)

Owners used to struggling with accounting believe the system must be harder, and invent rules such as depreciating bank balances or treating a profit distribution that is later spent on a hire as “not an expense.” His answer: “Cash is cash.” Profit is a reward for equity owners above Owner’s Comp.

Others try to simulate the accounts with a spreadsheet or a revised chart of accounts, or leave it to a bookkeeper. Then it fails because it is not in the path of the owner’s behavior. Spreadsheets and ledgers are “too late,” as “coming up with a battle plan after the battle is over is useless.” The bank is where in-the-moment decisions occur.

Profit First Professionals (PFPs) (author’s heading)

A PFP (bookkeeper, accountant, coach or other certified expert) provides experience and accountability, like a gym trainer, and can help when a bookkeeper or accountant resists. His own bookkeeper held his feet to the fire after he fell off the wagon. The chapter closes with Roger Bannister: “The man who can drive himself further once the effort gets painful is the man who will win.” The Take Action step is to meet with the accountant, bookkeeper or coach, ideally a PFP, to guard against over-allocating to PROFIT and under-allocating to TAX, schedule quarterly check-ins, and set up the bank accounts now if not already done.

Key Concepts and Distinctions

• Accountability buddy or group: A person or group who shares the goal and checks your follow-through.
• Significance: It addresses the failure mode that underlies every other mistake.
• Plowback and reinvestment as borrowing: Moving money out of allocation accounts to cover costs, however it is labeled.
• Significance: It is a symptom that expenses, not the system, are the problem.
• Asset versus expense in the efficiency sense: An asset is anything that yields more results at lower cost per result.
• Significance: It lets frugality coexist with investment in efficiency.
• Estimated taxes versus true tax liability: Estimates track last year’s income while the tax owed follows this year’s profit.
• Significance: It explains why the TAX account should never be tapped.

Essential Evidence and Examples

• Camp Widjiwagan: Mutual monitoring cut plate waste from several pounds to zero in a week, supporting the accountability argument.
• Twitter: Used as the case of growth chosen over profit, supporting the claim that grow-first is rarely rewarded.
• The two knife makers: Show that old equipment can look like savings while destroying output, supporting the efficiency definition of an asset.

Chapter Conclusion and Significance

The chapter concludes that Profit First rarely fails because the numbers are wrong. It fails when owners reintroduce their old habits: grabbing too much too fast, borrowing from their own allocations, choosing growth over profit, and complicating or bypassing the bank-based system. Each corrective rule restates the book’s premise, which is to put the constraint where behavior happens and to work with human nature.

The caveats are the author’s own: percentages should start low and rise slowly, and tax questions belong with a specialist rather than the book. Some evidence is anecdotal or time-bound (the Twitter figures are as of the printing), and the PFP recommendation comes from the originator of the program.

Questions for Reflection

1. Why does the author treat going it alone as the root failure, and which of the other seven mistakes would accountability not prevent?
2. How can an owner distinguish between a justified investment in efficiency (Mistake #4) and a “reinvestment” that is really borrowing (Mistake #5)?
3. The growth-versus-profit argument relies on survivorship and selection bias. How strong is that reasoning, and what evidence would test it?

Epilogue

Open in PDF — p. 210 (file not included in this release)

Chapter Objective and Through Line

The Epilogue closes the book with one analogy: Profit First is “the granny shot of accounting and money management.” Rick Barry, a twelve-time NBA All-Star, made 89.3 percent of his free throws shooting underhand, against a league average of 75 percent, while Shaquille O’Neal and Wilt Chamberlain shot under 53 percent overhand. Yet elite players refuse the underhand shot because they fear looking stupid, even though Chamberlain used it in his hundred-point game.

The point is that an effective method can look awkward or too simple, and the reader may be the first among friends to use it. The second move is an argument about change: habits are hard to alter, so the answer is a simple system that works with people as they are.

Chapter Structure at a Glance

1. The granny shot: a better method is avoided out of embarrassment.
2. Profit First as the granny shot: the reader may be mocked at the bank but, as the author puts it, “you know it works.”
3. Reader stories and the author’s result: turnarounds offered as evidence.
4. Systems over habit change: guardrails rather than willpower.
5. The closing instruction: ignore the naysayers and put profit first.

Section-by-Section Argument

The granny shot (analytical division)

Barry grips the sides of the ball at waist height and swings the arms up. Fewer joints means fewer variables, and more backspin makes a rim bounce more likely to fall in. Logic loses to the fear of looking inexperienced, and Profit First asks the reader to accept the same trade. p. 211 (file not included in this release)

Stories and the author’s own result (analytical division)

He receives at least five or six emails a day from readers. Two examples stand out: an organic farmer who tried Profit First after fourteen years of losses and turned a profit within six months, and a couple raising horses in Australia whose business was straining their marriage. He reports being debt-free and no longer waiting for a buyer or a big payout.

Systems rather than willpower (analytical division)

Citing Charles Duhigg’s “click, whirr” loop, he accepts that changing habits is “really, really hard.” Profit First instead captures the good parts of our habits and guards against the bad. No MBA, accounting course or financial-statement skill is needed, and the reader is not asked to “fix” who they are, only to add guardrails against “humanness.” p. 213 (file not included in this release)

Key Concepts and Distinctions

• The granny shot: A counterintuitive but more consistent method.
• Significance: It recasts the simplicity of Profit First as a strength.
• Click, whirr: A trigger sets off an automatic routine.
• Significance: It supports a system that intercepts the routine instead of demanding willpower.

Chapter Conclusion and Significance

The conclusion is motivational as much as logical: the method works, and the only real obstacle is willingness to look unconventional. Financial freedom, he says, is “just a few small plates away.” The evidence is testimonial and chosen by the author, and the sports claim is an analogy rather than proof about accounting.

Questions for Reflection

1. Where does the granny-shot analogy fit Profit First well, and where does it break down?
2. What kinds of habits might a bank-account structure fail to guard against?
3. What additional evidence would you want beyond stories the author has collected?

Appendix 1: The Profit First Quick Setup Guide

Open in PDF — p. 216 (file not included in this release)

Chapter Objective and Through Line

The guide condenses the whole routine into a checklist: a one-time setup at two banks, then fixed actions every day, on the tenth and twenty-fifth, each quarter and each year. Its purpose is to let the reader run the system without rereading the book. Bank 1 holds the day-to-day accounts and Bank 2 removes the temptation to “borrow” from the profit and tax reserves.

One-Time Setup

1. Set up the five foundational checking accounts at your current bank (Bank 1): INCOME, PROFIT, OWNER’S COMP, TAX, OPEX.
2. Set up two savings accounts at a different bank (Bank 2): PROFIT HOLD and TAX HOLD.
3. Determine the Target Allocation Percentages (TAPs) using the Instant Assessment, but start with Current Allocation Percentages (CAPs) the business can reasonably manage for the rest of the current quarter.

Recurring Routine

• Every day: deposit all sales receipts into INCOME; with advanced accounts, deposit reimbursements and retainers into their accounts; spend a minute reviewing Bank 1 balances.
• Every tenth and twenty-fifth: transfer all INCOME funds to the Bank 1 accounts by CAPs; move all PROFIT and TAX money to PROFIT HOLD and TAX HOLD (leaving $0.00 at Bank 1); move fixed dollar amounts such as payroll from OPEX; pay owner salaries from OWNER’S COMP; pay bills from OPEX.
• Every quarter: take 50 percent of PROFIT HOLD as a distribution, pay tax liabilities from TAX HOLD, and meet with an accounting practitioner or Profit First Professional to adjust the CAPs.
• Every year: review financials with a professional and make year-end contributions to the Vault, retirement accounts or capital purchases.

Questions for Reflection

1. Why does the guide have owners start with CAPs rather than TAPs, and what would go wrong otherwise?
2. Which step in the routine most directly protects against the mistakes in Chapter 11?

Highlights

• But there is one really friggin’ nagging problem: eight out of ten businesses fail, and the number one reason they fail is lack of profitability. According to a Babson College report, “A lack of profitability is consistently the major reason cited for business discontinuation.”* Are you surprised? Probably not. I wasn’t. It’s true, and it makes me want to drown my sorrows in Margaritaville. The majority of small businesses, and medium businesses and even some big ones, are barely surviving. That guy driving the new Tesla whose children go to private school via chauffeur and who lives in a massive house and runs a $3 million company, is one bad month from declaring bankruptcy. (Page 17)
• You know the formula I’m talking about: Sales − Expenses = Profit. That crusty, bifocal-wearing, old-person-smelling formula at first blush makes total sense. Sell as much as you can, then pay the bills, and what is left over is profit. Here’s the problem: there are never any leftovers. Flap. Flap. Flap. Splat. The old profit formula creates monsters of businesses. Cash-eating monsters. But we stay loyal to the formula, and things get worse. (Page 19)
• Chapter 1 YOUR BUSINESS IS AN OUT-OFCONTROL CASH-EATING MONSTER (Page 24)
• If you think operating your business is closer to a horror story than to a fairy tale, you’re not alone. Since I wrote my first book, The Toilet Paper Entrepreneur, I’ve met tens of thousands of entrepreneurs; and let me tell you, most are struggling to tame the beast that is their business. Many companies—even those that appear to have it all together, even the big guys who seem to dominate their industries—are one bad month away from total collapse. (Page 25)
• The silence continued for two painfully awkward minutes until Adayla walked back into the room carrying her piggy bank, the one she had received as a gift when she was born. It had clearly been cared for; even with all those years of use, there wasn’t a single chip or crack on the bank. She had secured the rubber stopper in place with a combination of masking tape, duct tape, and rubber bands. Adayla set her piggy bank down on the dining room table and slid it toward me. Then she said the words that will stay with me until the day I die: “Daddy, we’re going to make it.” That Valentine’s Day I woke up feeling like Debbie Horovitch felt after her Instant Assessment: like a fool. But by the end of the day I’d learned what net worth really is, thanks to my nine-year-old daughter. (Page 29)
• When I sat down to evaluate where I went wrong, I realized that while my own spending and arrogance definitely played a part, I also lacked knowledge. I had mastered how to grow businesses quickly, yet I never really graduated to understanding profitability. I had learned how to collect money, for sure, but I had never learned how to keep it, how to control it or how to grow it. (Page 30)
• I knew how to grow a business from nothing, working with whatever resources I had; but as revenue increased, so did my spending. I discovered that this was the way I ran both my personal life and my business. I took pride in making magic happen with pennies in my pocket, but as soon as I got some real cash, I made sure that I had a very good reason to spend it. It was a check-to-check lifestyle, but sustainable—as long as sales were sustained and did not dip. (Page 30)
• Money problems occur when one of two things happen: Sales slow down. The problem here is obvious when you operate check-to-check and sales slow down: when your one big client goes out of (Page 30)
• business, or that big deal you were banking on falls through, you won’t have enough to cover expenses. (Page 31)
• Sales speed up. This problem here is not obvious, but it is insidious. As your income climbs, expenses quickly follow. Big deposits feel great, but they are irregular. Consistent incoming cash flow is hard to sustain. A great quarter can trick you into believing your business is on a permanent upswing, and you start spending like this is the new normal. But drought periods come quickly and unexpectedly, causing a major gap in cash flow. And cutting back on expenses is nearly impossible because our business (and personal) lifestyle is locked in at our new level. Exchanging the newly leased car for a rust bucket, laying off employees because we’re overstaffed, saying no to our partners—all of this is very hard to do because of the agreements and promises we made. We don’t want to admit we’ve been wrong in how we’ve been growing our business. So rather than reduce our costs in any meaningful way, we scramble to cover ridiculously high expenses. We steal from Peter to pay Paul, hoping for another big payout. (Page 31)
• We assume that multimillion-dollar companies are turning big profits, but it’s rare to find a truly profitable business. Most entrepreneurs are just covering their monthly nut (or worse) and accumulating massive debt. (Page 31)
• Why the hell is success constantly defined by applying the Super Size Me principle to your business? Does more revenue mean you are more (Page 31)
• successful? No. I know far too many big businesses with owners who are in pure panic and use lawn furniture to decorate the inside of their houses because they have to funnel every spare penny into their businesses to keep them from sinking. Is that success? Hardly. (Page 32)
• Jason Fried, cofounder of Basecamp, wrote an article for Inc.* in which he talked about the demise of his favorite Chicago pizza joint. The owners did everything right—except that they grew too fast. After building their business slowly, they suddenly scaled from twenty to forty locations. Sales could not outpace their debt, and Fried’s beloved pizza chain was forced to close. The perfect size for your business? It will happen naturally, when you take your profit first. You will reverse engineer all the elements of your business, and as Fried says, “the right size will find you.” (Page 32)
• Here’s the deal, my friend: Profit is not an event. Profit is not something that happens at year-end or at the end of your five-year plan or someday. Profit isn’t even something that waits until tomorrow. Profit must happen now and always. Profit must be baked into your business. Every day, every transaction, every moment. Profit is not an event. Profit is a habit. (Page 33)
• Do you know the saying “Revenue is vanity, profit is sanity, and cash is king”? It is a succinct reminder that your job is to maximize profit, regardless of the current size of your business. As you focus on profit, you’ll discover new ways to both streamline and grow your business. It doesn’t work the other way around. The lemming mentality of growing first with the hope of finding profit in the process, is so bass ackward it drives me nuts. (Page 33)
• Without an effective money management system that does not require massive mind-set change, we get stuck in trying to sell our way out of our struggles. Sell more. Sell faster. Get money any way you can. It is a trap—a dangerous trap that would even have Frankenstein’s monster poopin’ his panties. It’s the Survival Trap. (Page 36)
• The Survival Trap promises fast money, but when we’re caught in it, we, like Ernie, rarely think about the massive cost of opportunity; and most of the time, we can’t discern profitable income from debt-generating income. Instead of being the world’s best at one thing, mastering the process of delivering perfectly and super-efficiently, we end up doing a greater variety of things and becoming less and less efficient at each step while our businesses become harder to manage and costlier to run. (Page 38)
• GAAP’s fundamental flaw is that it goes against human nature. No matter how much income we generate, we will always find a way to spend it—all of it. And we have good reasons for all our spending choices. Everything is justified. Soon enough, whatever money we had in the bank dwindles down to nothing as we struggle to cover every “necessary” expense. And that’s when we find ourselves in the Survival Trap. (Page 41)
• A secondary flaw is this: GAAP teaches us to focus on sales and expenses first. Once again, it works against our human nature, which urges (Page 41)
• us to grow what we focus on. It’s something called the Primacy Effect (more on that in the next chapter)—we focus on what comes first (sales and expenses) and actually become blind to what comes last. Yes, GAAP makes us blind to profit. (Page 42)
• There is a saying: “What gets measured, gets done.” GAAP has us measure sales first (it is the top line, after all), and therefore we sell like mad while expenses are treated like a necessary evil to support—you guessed it—more sales. We spend all that we have because we believe we must. And we use terms like “plowback” or “reinvest” to feel good about it. Profit? Your salary? Mere afterthoughts. Leftovers. (Page 42)
• If you were Spock, the relentlessly logical Vulcan on Star Trek, in addition to your pointy ears and awkwardly tight uniform, you would follow all the accounting instructions necessary to pinpoint your numbers. On a weekly basis you would study your income statement, tie it into you balance sheet, and, of course, do an analysis of your cash flow. Next you would run the critical ratios, like the OCR (operating cash ratio), and tie all this into your budget and projections. Then you would evaluate the associated KPIs (key performance indicators). You would do it all, and you would know exactly where your profits stand at any time. But you don’t, do you? Not even close. I don’t. In fact, I still can’t read those documents well. (That’s why I employ a couple of Spocks—my accountant and my bookkeeper.) I am a human. And so are you. And I strongly suspect you are a Captain Kirk. And that is a good thing, because you are the perfect person to lead your corporate ship to profits at warp speed. (Page 44)
• But I have good news, people. I designed Profit First so that you don’t have to change yourself at all. This is a critical point. You have always had an opportunity to change yourself and read your financial statements, sync your accounts payable and accounts receivable, make sure you are within budget, and make sure all the financial ratios are right. If you did all that, you would know where your profit stands all the time. But only Spock and accountants (and actually not that many of them) can and do that. Most entrepreneurs revert to checking their bank balance and going with their gut. (Page 45)
• As Charles Duhigg explains in The Power of Habit, it is human nature to revert to established habits in times of stress. (Page 45)
• Chapter 2 THE CORE PRINCIPLES OF PROFIT FIRST (Page 48)
• It was then that I realized: every penny my company made was going onto one huge plate, and I was gobbling it all up, using every last scrap to operate my business. Every dollar that came in went into one account, my operating account, and I was “eating it all.” (Page 49)
• THE FOUR CORE PRINCIPLES OF PROFIT FIRST (Page 52)
• In 2012, a report by Koert Van Ittersum and Brian Wansink in the Journal of Consumer Research concluded that the average plate size in America had grown 23 percent between the years 1900 and 2012, from 9.6 inches to 11.8 inches. Running the math, the article explains that should this increase in plate size encourage an individual to consume just fifty more calories per day, that person would put on an extra five pounds of weight each year. Year after year, that adds up to a very chunky monkey. (Page 52)
• 1. Parkinson’s Law: Why Your Business Is Like a Tube of Toothpaste (Page 54)
• In 1955, a modern philosopher named C. Northcote Parkinson came up with the counterintuitive Parkinson’s Law: that the demand for something expands to match its supply. In economics, this is called induced demand—it’s why expanding roads to reduce traffic congestion never works in the long term because more drivers always show up in their cars to fill those extra lanes. (Page 54)
• You see the more we have of something, the more of it we consume. This is true for anything: food, time, even toothpaste. (Page 54)
• Isn’t it funny how much we change based upon what is available? Here is what’s fascinating: Parkinson’s Law triggers two behaviors when supply is scant. When you have less, you do two things. The first is obvious: you become frugal. When there is less toothpaste in the tube, you use less to brush your teeth. That is the obvious part. But something else, far more impactful happens: you become extremely innovative and find all sorts of ways to extract that last drop of toothpaste from the tube. (Page 55)
• If there is one thing that will forever change your relationship with money, it is the understanding of Parkinson’s Law. You need to intentionally make less toothpaste (money) available to brush your teeth (to operate your business). When there is less, you will automatically run your business more frugally (that’s good) and you will run your business far more innovatively (that’s great!). (Page 55)
• If you first extract your profit and remove it from sight, you’ll be left with a nearly empty toothpaste tube to run your business. When less money is available to run your business, you will find ways to get the same or better results with less. By taking your profit first, you will be forced to think smarter and innovate more. (Page 55)
• 2. The Primacy Effect: Why the First Part of Profit First Matters (Page 55)
• We place additional significance on whatever we encounter first. (Page 55)
• When we follow the conventional formula of Sales − Expenses = Profit, we are primed to focus on those first two words, Sales and Expenses, and treat Profit as an afterthought. (Page 56)
• 3. Remove Temptation: Once You Take Your Profit First, Put It Away (Page 56)
• Money works the same way. As you implement Profit First, you are going to use the powerful force of “out of sight, out of mind.” As you generate a profit (which, remember, starts today), you are going to remove the money from your immediate access. You won’t see it, so you won’t access it. And just like anything that you don’t have a reasonable degree of access to, you will find a way to work with what you do have and not worry about what you don’t. (Page 57)
• 4. Enforce a Rhythm (Page 57)
• When you get into a rhythm with your cash management you’ll have your finger on the pulse of your business. You will monitor your cash position every day by just looking at your bank account. Log in. Spend two seconds looking at your balances. Log out. (Page 57)
• Profit First sparks faster growth because it makes you reverse engineer your profitability. When you take your profit first, your business will tell you immediately whether it can afford the expenses you are incurring; it will tell you whether you are streamlined enough; it will tell you whether you have the right margins. If you find that you can’t pay your bills after taking your profit first, you must address all those points and make the fixes. (Page 58)
• THE NEW ACCOUNTING FORMULA (Page 59)
• Sales − Profit = Expenses (Page 59)
• 1. Use Small Plates—When money comes into your main INCOME account, it simply acts as a serving tray for the other accounts. You then periodically disperse all the money from the INCOME account into different accounts in predetermined percentages. Each of these accounts has a different objective: one is for profit, one for owner compensation, another for taxes, and another for operating expenses. Collectively, these are the five foundational accounts (Income, Profit, Owner’s Comp, Tax, and Operating Expenses), and where you should get started, but advanced users will use additional accounts, outlined in Chapter 10. (Page 59)
• 2. Serve Sequentially—Always, always allocate money based upon the percentages to the accounts first. Never, ever, ever pay bills first. The money moves from the INCOME account to your PROFIT account, OWNER’S COMP, TAX, and OPEX (OPERATING EXPENSES). Then you pay bills only with what is available in the OPEX account. No exceptions. And if there isn’t enough money left for expenses? This does not mean you need to pull from the other accounts. What it does (Page 59)
• mean is that your business is telling you that you can’t afford those expenses and need to get rid of them. Eliminating unnecessary expenses will bring more health to your business than you can ever imagine. (Page 60)
• 3. Remove Temptation—Move your PROFIT account and other “tempting” accounts out of arm’s reach. Make it really hard and painful to get to that money, thereby removing the temptation to “borrow” (i.e., steal) from yourself. Use an accountability mechanism to prevent access, except for the right reason. (Page 60)
• 4. Enforce a Rhythm—Do your allocations and payables twice a month (specifically, on the tenth and twenty-fifth). Don’t pay only when there is money piled up in the account. Get into a rhythm of allocating your income, and paying bills twice a month so that you can see how cash accumulates and where the money really goes. This is controlled recurring and frequent cash flow management, not by-the-seat-of-your-pants cash management. (Page 60)
• In their book Switch, Chip and Dan Heath explain the concept of “lowering the bar.” We entrepreneurs are all programmed to “raise the bar.” Go bigger. Live bolder. Take on more. But I have found that isn’t always the best way to gain momentum. And if you intend to be profitable, it is time we start with a small “low bar” step. I want you to take one small, simple, and easy action that will start you down the path of permanent profitability. There is no excuse because it is so easy. (Page 61)
• Right now I want you to set up your PROFIT account. It is the first step in the Profit First system, so do it right now. Call your bank (or do it online) and set up one new checking account. Don’t get mired in whether it should be a savings account or a sweep account or any of that. The five seconds you spend thinking about it cost more than the little dribble of interest it will yield. Your goal is just to get started and not to slip back. (Page 61)
• After setting up this new checking account at your bank, nickname the account PROFIT, and from this moment forward from any deposit you put into your normal checking account, transfer 1 percent of that deposit into (Page 61)
• your PROFIT account. Then proceed with your business and processes and money management as you have in the past. Just add to the PROFIT account, and never touch it (until you get to the section of this book where I explain what to do with it). If you get a $1,000 deposit, I am telling you, starting today, transfer $10 into your PROFIT account. If you could run your business off $1,000, you can surely run it off $990. If you get $20,000 in deposits, you transfer $200 into your PROFIT account. If you can run your business off $20,000 you absolutely can run it off $19,800. You’ll never miss that 1 percent. It is a low bar. (Page 62)
• TAKE ACTION: EASY FIRST STEPS 1. Trust the process. This works, but it is unfamiliar. So you will resist. Commit to, for now, relinquishing your resistance and comfort in doing what you did in the past. First, trust the process. Then prove it to yourself. 2. Open just one new account: PROFIT. For simplicity’s sake, make it a checking account. Don’t worry about the insignificant interest implications of savings and other accounts. Your goal for now is to get started immediately and decisively. (Page 62)
• 3. Transfer 1 percent of your current money into the PROFIT account. You have “seeded” the account. Don’t touch it. Never transfer it. Just let it sit for now. (Page 63)
• Chapter 3 SETTING UP PROFIT FIRST FOR YOUR BUSINESS (Page 64)
• THE FIVE FOUNDATIONAL ACCOUNTS (Page 67)
• Here are the five checking accounts you need to set up: 1. INCOME 2. PROFIT 3. OWNER’S COMP 4. TAX 5. OPEX (Page 67)
• TWO “NO-TEMPTATION” ACCOUNTS (Page 68)
• If something is not readily available, we are unlikely to go through an extraordinary measure to consume it. Your profit is for you, and if you can access it easily, you might be tempted to “borrow” from it to cover expenses. And the tax money? That belongs to the government. We are going to make sure you never borrow (a soft term for “steal”) from these accounts. (Page 68)
• 1. “I haven’t ever been profitable in the past, so how can I take my profit now?” People have difficulty accepting the notion that they can start taking profits right away because it seems like some kind of woo-woo accounting trickery. It’s not (in fact, it’s regular accounting that employs trickery). By taking profit first, you’re fundamentally changing the way you run your business. When I hear this question, I always explain Parkinson’s Law: you spend every penny you have available and stretch every dollar in the lean times to keep your business moving forward. I’m simply asking you to remove the profit first, and operate on less. You’ve done this already, and you’ve found a way. There is a saying: “Nothing changes if nothing changes.” If you don’t change the way you take your profit, you will never take a profit. (Page 70)
• Here’s how to proceed: if you like your current bank, tell them that their requirements for a “minimum balance” and “transfer fees” and all those rules they have don’t work for you. Ask them to wave the minimum balance requirement and other fees. Yes, you can ask that. Your bank will either comply with your request, or they won’t. If they do, kudos to you. If they don’t, move on to a new bank. (Page 72)
• TAKE ACTION: GET YOUR BUSINESS PROFITREADY (Page 72)
• Step 1: Set up the five foundational accounts: an INCOME account, a PROFIT account, an OWNER’S COMP account, a TAX account, and an OPEX account. (Page 72)
• In most cases, you will already have one or two accounts with your bank. Keep the primary checking account you already have as your OPEX Account, and set up the remaining accounts: INCOME, PROFIT, OWNER’S COMP, and TAX. For simplicity’s sake, set them all up as checking accounts. Some banks may charge fees or have minimum balance requirements. Don’t let that deter you. Ask to speak to the bank manager and negotiate the fees and requirements. If the manager is unwilling to negotiate, find a new bank. Step 2: Set up two more external savings accounts with a bank other than the bank you use for daily operations. One account will be your no-temptation PROFIT HOLD account. The second will be your notemptation TAX HOLD account. Set them up with the ability to withdraw money directly from the respective checking accounts at your primary bank. Step 3: Don’t enable any of the “convenience” options for your two external no-temptations accounts. You don’t need or want to view these accounts online. You don’t want checkbooks for these accounts. And you definitely do not want a debit card linked to those accounts. You just want to deposit your profit and tax reserves and forget it … for now. (Page 73)
• Chapter 4 ASSESSING THE HEALTH OF YOUR BUSINESS (Page 74)
• Fig. 3. Profit First Instant Assessment Form Visit http://bit.ly/2iFfla6 on a web-enabled device to view a larger, printable webpage with this image. (Page 78)
• A financially healthy company is a result of a series of small daily financial wins, not one big moment. Profitability isn’t an event; it’s a habit. (Page 88)
• IF YOUR BUSINESS IS BRAND-NEW How does Profit First work if you just launched your business and have no revenue? Should you wait until you have some to start using Profit First? Heck, no. Starting with squat, with your whole business future ahead of you, is actually the best time to start using Profit First. Why? Because it allows you to form a powerful habit right from the get-go, when your business is forming and, perhaps more important, prevents you from developing bad financial habits that can be difficult to break. Also, in the early stages of building a business, you need to spend as much time as possible on the selling and the doing; systems and processes come later. For these reasons, it’s best not to worry about getting the exact right percentages for your business. Simply use the percentages in the Instant Assessment for your target allocations, but start at 1 percent allocation for the PROFIT account (Why 1 percent? You’ll find out in the next chapter), 50 percent for OWNER’S COMP, and 15 percent for the TAX account. Use quarterly adjustments to step up to higher percentages and nudge your business closer to the TAPs recommended in this book. And as for the advanced Profit First strategies I share in the end of the book—don’t worry about any of that until your business has been active for at least a year. The goal for new businesses is to form the basic core of the Profit First good habit and then spend every other waking second getting your baby off the ground. (Page 90)
• TAKE ACTION: COMPLETE THE INSTANT ASSESSMENT (Page 90)
• Step 1 (the one and only step): This entire chapter is really one big action step, so if you have not yet completed an Instant Assessment on your business, do it now. Can you get a lot out of this book if you table this exercise for when you have more time or feel up to facing reality? Sure. Will you get the most out of reading this book and see results quickly if you don’t? Nope. So stop right now and do it. I’m waiting … do it now (Page 90)
• Chapter 5 ALLOCATION PERCENTAGES (Page 92)
• I’ve seen entrepreneurs kick-start their Profit First system by taking a profit percentage of 20 percent immediately. They say, “This is so simple. I get it. Bammo! Twenty percent! I’m done. Next problem.” Not so fast, chiefy. This is a classic mistake—one I’ve made myself. Going full throttle into Profit First on the first day is like donating five gallons of blood at your first blood drive. You know what would happen if you tried to do that? You would die. The body has less than two gallons of blood pumping through it, so you’d keel over way before you reached your five-gallon goal anyway. However, there is a way to reach your goal in a safe way. If we donate small amounts over time, eventually we will donate five gallons—cumulatively. The Target Allocations Percentages, which we call TAPs, are simply the targets you are moving toward. To be clear, TAPs are, not—I repeat, are not —your starting point. I derived the TAPs from surveys and evaluations of approximately one thousand of the most fiscally elite companies, across all industries and of all sizes, as well as an analysis of some of the thousands of companies who have implemented Profit First and, as a result, joined the fiscally elite. Aspire to move toward the TAPs. At this point, you may be thinking, “Mike, you don’t know my industry. I could never hit those numbers.” This is when I have to bring out the big guns, people like Henry Ford, who said, “If you think you can or think you can’t, you’re right.” Be optimistic when you assume profit capabilities for your business or your industry. In other words, think you can. (Page 94)
• Current Allocation Percentage (CAP) is where your business is today. This is the number you will adjust slowly but consistently over time to get closer and closer to the TAPs. For example, the Profit TAPs for your size business may be 20 percent, but your historical profit allocations may have been 0 percent. (If that is you, don’t fret; it’s common.) If you haven’t made profit allocations until now, then your profit CAP is 0 percent. For your company to join the fiscally elite, you will slowly, deliberately, and consistently move toward the TAPs. What you will do is move from 0 percent profit CAP to 1 percent. Then, next quarter, you will move your CAP to 3 percent, and then next quarter, 5 percent. (Page 95)
• YOUR PROFIT TARGET ALLOCATION PERCENTAGE (PROFIT TAP) (Page 95)
• Now you need to do a little bit of research to set more specific target numbers. There are a few ways to approach this: 1. Research public companies: look at the financial reports public companies are required to make available. Do a quick Internet search using the term financial market overview, and you will find dozens of Web sites that report the financials for public companies. Look up at least five companies in your industry or a similar industry. If you don’t find your niche, try expanding. For instance, if you find no public DJ companies, expand to entertainment companies and select five that come close. (Tip: My preference is Marketwatch.com for these reports, because the site is easy to navigate. You might also try Yahoo! Finance and Google Finance.) (Page 96)
• For our purposes, look up the income statements for the last three to five years. If you really want to dig in, check out the balance sheets and cash flow statements for these companies, too. For each year, divide the net income (profit) number by the total sales/revenue number.* Then come up with the average. This is how you find the profit percentage for any public company. Do this for each of the five public companies you look at, and you will find the overall industry profit average. Use that overall industry profit average as your Profit TAP. (Page 96)
• 2. Review your tax returns for the last three to five years and determine your most profitable year—based on percentages, not on dollar amounts. Why do we want the percentage? Because a billion-dollar company that reports only a million dollars in profit is in big trouble. Even if it had only one bad day, a million bucks wouldn’t be enough to bail it out. But a five million-dollar company that reports a million in profit is kicking butt and taking names. That li’l ole company spits at bad days. (Page 96)
• 3. Or, the easiest way, just pick your profit percentage number based on your projected revenue for this year, using revenue for the last twelve months from the Instant Assessment form you filled out for Chapter 4. (You did fill it out, right?) Remember, the form is also available for free, downloaded from the Resources section at MikeMichalowicz.com. (Page 97)
• If your sales were to stop completely, with not a single deposit coming in, here’s a good longevity rule of thumb: 1. 5 percent profit allocation = 3 weeks of operating cash. 2. 12 percent profit allocation = 2 months of operating cash. 3. 24 percent profit allocation = 5 months of operating cash. (Page 97)
• FAT MARGINS DRAW STIFF COMPETITION The goal is to make your profit allocation percentage as high as possible. However, super high profit percentages are not sustainable. At least not for long, and definitely not if your revenue stays stagnant. The reason for this is that if you can pull off consistently fat profits—say 50 percent allocated to Profit and only 10 percent of revenue to your Operating Expenses—your competitors will figure out what you’re doing. Then, to get more business, they will drop prices (they likely have the profit margins to afford it). When that happens, you will have to drop prices, too, in order to stay in business. For competitive sharks, fat margins can be like blood in the water. The only way to keep big margins is to milk them for all they’re worth when you have them and keep innovating to find new ways to bump up profitability. (Page 98)
• OWNER’S COMP TAP (Page 98)
• There are two options to consider when choosing your Owner’s Comp TAP number. Either (Page 98)
• 1. Take a realistic look at the work you do. If you have a small company with, say, five employees, you may call yourself the CEO—but that’s just the title on your card. It’s likely you are doing a lot of other work. You probably spend a lot of time selling, completing projects, handling customers, and dealing with human resources (HR) concerns. In reality, around 2 percent of your time is spent actually doing the job of CEO: vision planning, strategic negotiations, acquisitions, reporting to investors, addressing the media, etc. Determine your salary based on what you are doing 80 percent of the time, and what you would reasonably pay employees to do those jobs. Then evaluate pay for all equity owners who work in the business. (Page 99)
• Add up the salaries that represent your Owner’s Comp draw. The percentage of revenue that you set as your Owner’s Comp TAP must, at minimum, cover Owner’s Comp draw. Remember, you will likely get raises—maybe even a bonus for a job well done. So make the percentage one and a quarter times the amount you determine for your salaries, so you can adjust for revenue fluctuations. Say you work with four equity owners in a business with a revenue of $1,000,000, who draw a salary of $50,000 each, you need to set your Owner’s Comp TAP to at least 25 percent. (Page 99)
• Or, 2. Pick the percentage I suggested in the Instant Assessment, based on your Revenue Range. (Refer to Figure 4.) The money that is transferred into this account is divided among all equity employees. It does not have to be split up equally, nor does it have to be split up based on your equity percentages. The Owner’s Comp is a negotiated agreement. (Page 99)
• Don’t Underpay Your Most Important Employee (Page 100)
• Michael Gerber, in his classic must-read book The E-Myth Revisited, explains that we should work on our business, not in it. This “on versus in” philosophy is spot-on, and yet most entrepreneurs have trouble executing it. Working on the business does not mean hiring a bunch of people to do the work and then spending all the livelong day answering their never-ending questions about how to do the job (the job you used to do). Working on your business is about building systems. Period. (Page 101)
• However, what Rodrigo and so many entrepreneurs miss is that growing a company is not an overnight switch from doing all of the work to none of the work. The transition from working in the business to working on the business happens over time—slowly, deliberately, one small step followed by another small step. (Are you starting to see the theme here?) This is the reasoning behind the Owner’s Comp percentages in the Instant Assessment—larger percentages for owners when the company is tiny and smaller percentages as the company grows. (Page 101)
• Profit First is not about accounting to the exact penny. That’s what your bookkeeper and accountant do. It is about handling your accounting quickly and easily with numbers that are as close to accurate as possible. We work percentages off the Real Revenue number, and this is true for all your “small plate” accounts. (Page 103)
• The Tax plate, so we are clear, is designed to pay the direct Tax liabilities of the business and (this is the big one), the personal income taxes of the owners. Let me say that again because this often gets missed: your company (assuming you own it) will reserve your personal income tax liability for you, and then pay it. Here’s the deal: you started your business in part to achieve financial freedom. So if that is true, shouldn’t your company pay your taxes for you? Hellll, yeah. So that is exactly what is going to happen. (Page 103)
• One goal of the Profit First system is that the company takes care of all forms of Tax responsibility. It’s mandatory that you talk with your accountant so she can advise you on all the ways you and your business will be taxed. Here are three different approaches for determining your Tax TAP: 1. Look at your personal and business tax returns. Add up your taxes and then determine the percentage of taxes you paid compared to your Real Revenue. Do this again for the prior two years. Looking at your taxes as a percentage of Real Revenue for the last three years will give you a good sense of your ongoing tax responsibility. 2. From your accountant get your estimated tax responsibility for your business, year to date (YTD), and then determine your Tax percentage of your YTD Real Revenue. 3. Or simply use 35 percent for U.S.-based businesses, and if you have a business in another country, simply use the average prevailing rate of taxes for an individual at your income rate as your Tax number. It may not be perfect, but it’s usually pretty effective. And while the optimal number will have you neither paying additional taxes at the end of the year nor receiving a refund, it is better to guess a little too high, get a refund and consider what to do with the extra cash than to get a call from your accountant, Keith, because you don’t have enough money, and have to ask your daughter if you can borrow from her piggy bank. Trust me. (Page 104)
• TAKE ACTION: APPLY YOUR ADVANCED KNOWLEDGE (Page 105)
• Step 1: Following the steps detailed above, determine your custom Profit, Owner’s Comp, and Tax percentages based on your industry and other factors. Set these as your TAPs, your targets. This is the X on the map of where we are heading, but it is not where we are starting. (Page 105)
• Step 2: Because you chose to get down to the nitty-gritty and determine your exact Profit, Owner’s Comp, and Tax percentages, stop now and adjust the numbers in your Instant Assessment chart. Step 3: Set your CAPs. For the remainder of this quarter, set your CAPs 1 percent “better” than what you have done historically— meaning increase your Profit, Owner’s Comp, and Tax all by 1 percent and cut your Operating Expenses by 3 percent. Every quarter we will push the CAPs to an even better percentage. Over time you will continue a relentless march toward a healthier and healthier company, and a fatter and fatter wallet. (Page 106)
• Chapter 6 PUTTING PROFIT FIRST INTO MOTION (Page 107)
• TAKE ACTION: GET READY FOR A GREAT YEAR! Step 1: Start a “celebration list”: Come up with ideas for how to spend your quarterly owner’s distribution. Include small treats and big indulgences. Post the list where you can see it, for inspiration and motivation; and as a reminder when the quarter comes around and you convince yourself there are more practical uses for the money. If one of those treats is a trip to meet up with me at an event and tell me your Profit First success story, that would be pretty cool. But if it’s flying me down to see you so we can go kitesurfing together, that would be really, really cool. Step 2: Block out the tenth and twenty-fifth on your calendar into perpetuity. You will need about five minutes to do the core process of checking the balances of your foundational five accounts to see where you stand, do the allocation of funds, and to transfer PROFIT and TAX to the no-temptation accounts. If you have a bookkeeper, she can do the other elements like pay bills, reconcile accounts, and applaud you for being a profit-making machine. (Page 131)
• Chapter 7 DESTROY YOUR DEBT (Page 132)
• The premise is simple—we avoid pain and move toward pleasure, putting a significant emphasis on the moment and very little emphasis on the long term. Immediate pain gets the ball rolling, but pleasure keeps it moving. You probably picked up this book because of pain, and you will likely see results quickly because your efforts will reduce the pain. But the only way you will be able to make this work forever is if you get immediate pleasure each time you exercise your new habits. Just as at the gym, the pain of seeing your muffin top in the mirror will only motivate you to work out so much before you decide it isn’t worth the effort. The only way to turn it into a sustained habit is to start enjoying your workouts. (Page 136)
• Give yourself more joy when you choose not to spend money than you do when you choose to spend it. Give yourself more joy when your bottom line grows (not just the top line). Give yourself tons of joy when your profit percentage grows. (Page 136)
• The goal here is to cut cost, not to compromise the business. You can fire all your people, shut down your Web site, refuse to pay a penny to anyone, and, seriously, move into a van down by the river with your new roommate, and struggling motivational speaker, Matt Foley … but you’ll be out of business. You want to cut the fat out of your business, the stuff that is not generating or supporting income for your company. But you don’t want to cut out the muscle, the stuff that you absolutely must do to deliver your product or service. (Page 139)
• Print and Mark Up Docs 1. Print out your current income statement for the last twelve months, as well as your current accounts payable report, your credit card statements, loan statements, and any other statements related to debt, and your last twelve months of payments made from any of your business bank accounts. If you do not have an income statement ready, just gather the other documents. 2. Go line by line through each expense (past and present), even if you are not incurring the expense anymore, and with the pen, mark the expense with a P for any expense that directly generates (P)rofit; R for any expense that while necessary, can be (R)eplaced with a less expensive alternative; or U for any expense that is (U)necessary for delivering your offering. (Page 139)
• 3. Review every expense, including salaries, commissions and bonuses for employees, rent for the office, equipment, health care, raw goods, your office Spotify subscription. Everything. If money goes out of the business, we need to categorize it as a P, R, or U. I realize these things can get very subjective, so slant toward sharpening the pencil. Also, consider outside help to get you through this process.* 4. Now circle any expense that is recurring (even if it happens to be in a different amount), meaning it will happen again at least once in the next year or more frequently, such as monthly or weekly. As an FYI, this is why we categorized all of your expenses, including ones that you haven’t incurred in a while; they are indicators of what may be coming down the pike (Page 140)
• Now Let’s Do Some Math 1. Add up all the expenses for the year. This includes everything you labeled and/or circled. Exclude any tax payments and owner’s distributions or salaries. Now divide that number by twelve to determine your monthly “nut”—the total amount you have decided you need to cover each month. 2. Determine the difference between your current monthly operating expenses and the number it must be according to your Instant Assessment. For example, if you currently have $52,000 in average monthly expenses and your Instant Assessment has your monthly expenses at $30,000, you need to cut your operating expenses by $22,000. There will be no justifying past spending mistakes, no saying, “But I need everything.” You don’t. Your healthy, booming competitor has figured it out. You need to put on your big-girl panties and accept that you spent too much, and today is the day we fix it. (Kinda creepy that I know you wear big-girl panties, isn’t it?) (Page 140)
• 3. Band-Aids come off more easily when you tear them off. Work a plan to cut expenses until you are operating at 10 percent below the target number on your Operating Expenses TAPs in the Instant Assessment. Start by cutting the U expenses first. Then find ways to reduce the R expenses with replacements or alternatives. And evaluate the P expenses to see if you can structure the expense more favorably. (Page 141)
• If your company is racking up debt, it is all too often because labor cost is too high. The problem with cutting labor costs is, our minds quickly come to defend and justify why people should stay: I own the company, I can’t do the work; I need to direct my team to do the work. Plus, they need a job (which is true); they are integral to the company (probably also true); the company will tank without them (super unlikely); and if I get rid of them, I won’t have people to do the work (hardly ever true). (Page 141)
• Evaluate each person and determine if her role is mandatory for operations to continue (not the person, but the role). If a person wears multiple hats (for example, is your receptionist also the in-house salesperson?), ask yourself whether each role is mandatory for operations to continue. (Page 142)
• In his extraordinary book, The Total Money Makeover, Dave Ramsey explains the Debt Snowball. It’s contrary to logic, but it plays exactly into the psyche of all of us human beings. Ramsey tells us that logic would say to pay off our debts with the highest interest rates first, but that doesn’t build emotional momentum. It is getting to tear up a statement—any statement, because it is fully paid off—that gives you a sense of momentum and gets you charged up to tackle the next one. Ramsey explains that you should sort all your debts from smallest to biggest, regardless of interest rates. Only when two debts are a similar amount should the one with the highest interest rate be paid first. (Page 149)
• TAKE ACTION: DOWN WITH DEBT! Step 1: Start the Debt Freeze. Stop any recurring payments and kill off anything you don’t need. Do whatever it takes to get your “monthly nut” down to 10 percent lower than your Instant Assessment suggests it should be. Step 2: Use 99 percent of your profit allocation toward wiping out your debt. With that remaining 1 percent, you still need to celebrate. I know it doesn’t amount to much, but you can still reward yourself. Even if you are strapped with debt you are eradicating, you still need to celebrate during the process, and a cash profit distribution to you, however small, helps you do that. Step 3: Start the Debt Snowball. Pay off your smallest outstanding debt first. As you wipe out each bill with recurring payments, use the freedup payments to tackle the next smallest debt. (Page 150)
• Chapter 8 FIND MONEY WITHIN YOUR BUSINESS (Page 151)
• If you want to increase profitability (and you’d better friggin’ want to do that), you must first build efficiencies. Focusing solely on increasing sales is like setting up a bunch of rain barrels next to your house and doing some frantic rain dance in a loincloth while ignoring a massive water source beneath your feet. (Page 153)
• Making your company more efficient is about more than just nixing extra coffee breaks and redlining your expenses. To tap into the river of profit flowing just under the surface of your company, you need to look at efficiency in every aspect of your business. Serving the same types of (great) clients with the same or very similar problems and perfecting your solutions so you can use them consistently to fix their problems are two routes of efficiencies. You want to duplicate your best clients, those who have a consistent need; and in turn, you want to reduce the variety of things you do for the fewest that will best serve your best clients’ needs. Think McDonald’s. That company is a moneymaking machine because they feed hungry people—who don’t care, at least in the moment, about their health as much as their hunger—with a few products: fries, hamburgers, and breaded chicken. The fewest things you can do repetitively to serve a consistent core customer need—this spells efficiency. (Page 156)
• I’m sure you know this scenario all too well. Those clients who barely pay you peanuts, yet constantly complain about how much you charge and how you do nothing right; the clients who demand you rework everything you’ve done for the third time and then never pay you for your work, or never pay you on time—those clients are costing you money. Get rid of them. Fast! (Page 161)
• Having clients with similar needs and very similar behaviors offers a few magical profit-making benefits: 1. You will become superefficient, because you now serve very few but consistent needs, rather than an excessive array of varying needs. 2. You will love working with your clones, which means you will naturally and automatically provide better service. We cater to the people we care about. 3. Marketing will become automatic. Birds of a feather flock together (for real) and that means your best clients hang out with other business leaders who have the “best client” qualities you’re looking for. Your best clients are awesome, remember? You love them and they love you, and that means they will talk you up every chance they get. (Page 162)
• THE PARETO OVERLAP You may be familiar with the Pareto Principle, commonly known as the 80/20 rule. For the history buffs: Vilfredo Federico Damaso Pareto was an Italian economist who studied the distribution of wealth in Italy in the late 1800s. He discovered that 20 percent of the Italian population owned 80 percent of the land. Then he looked at his garden and observed that 20 percent of the peapods contained 80 percent of the peas. Then he looked down at his feet and exclaimed, “OMG, I own five pairs of clogs, yet I wear these superfly boots 80 percent of the time!” Pareto’s Principle also applies to your clients, in that 20 percent of them yield 80 percent of your revenue. It goes further—80 percent of your profit is derived from 20 percent of the products and/or services you offer. The key to this advanced strategy is to connect the two—your clients and your offering. Some of your top clients buy most of your profitable offerings; some of your top clients go for the offering with the lowest profit margin. Likewise, some of your weakest clients consistently purchase your profitable stuff and some are just weak all the way around, buying the same no-profit stuff over and over again. Once you see the overlap, the decisions become very easy. Get rid of the “bad” clients who only want your least profitable products and services. You are losing money here, catering to clients or customers who are not a good fit for your company. Find a new way to manage the weak clients who do buy your most profitable offerings. Often, “bad” clients can become better clients if you meet with them to set new expectations and methods of communication. Meet with your top clients who don’t buy profitable offerings, too. Find out how you can deliver profitable stuff to them. When you focus on Profit First, even when choosing the clients and customers you are willing to work with, you increase your profit dramatically. Not only do you save money by cutting expenses related to serving weak clients, who don’t buy profitable offerings; you also free up your time, energy and creativity to focus on the clients you love, who bring in the profit. Applied to your client base, the Pareto Principle is an advanced Profit First technique that does double duty—you save money and gain profit. Gotta love that! (Page 163)
• Selling more is the most difficult way to increase profits, because in the best-case scenarios, the percentages stay the same; and in the worst-case more common scenarios, expenses generated to support sales increase faster, resulting in smaller percentages and a smaller profit margin. (Page 165)
• TAKE ACTION: LET GO OF DEAD WEIGHT Step 1: Focusing on one aspect of your business (one that benefits your best customers), challenge yourself to figure out how to get two times the results for half the effort. Step 2: Using the parameters outlined in this chapter, identify your weakest clients. Fire the weakest links. I’m not suggesting that you get into “Take This Job and Shove It” mode. Don’t burn any bridges. Just politely end the relationships. You’re not dating anymore, but you can still be friends. (Page 165)
• Chapter 9 PROFIT FIRST—ADVANCED TECHNIQUES (Page 166)
• Chapter 10 THE PROFIT FIRST LIFE (Page 182)
• So, soul mate, you need to apply everything you’re doing right now (and planning to do) to fix your business with Profit First to your life, too. 1. Face the music. This step should be easier now that you’ve faced the truth about your company’s finances. Add up all of your monthly bills, plus your annual bills and the debt you owe. 2. If you have any debt at all, stop accruing more. Put a freeze on all purchases you cannot pay for with cash. 3. Establish a personal Profit First habit. Set up an automatic withdrawal so that every time you get paid, which should now be twice a month on the tenth and the twenty-fifth, a percentage immediately transfers into a retirement savings account. If you are carrying any amount of debt, keep the retirement percentage at 1 percent until the debt is paid off. Use every penny you have after necessary expenses to eradicate your debt. 4. Set up your “small plates.” Create five foundational accounts, multiple Day-to-Day accounts and Big Event accounts. A. INCOME Account. This is the account into which you make deposits. From this account, allocate money to the other accounts. Don’t use it for any other purpose. B. The VAULT Account. Initially, this is the “oh shit” account, the amount of savings you must have on hand to get through the month if—scratch that—when something dire happens. Now, Suze Orman recommends saving eight months’ worth of living (Page 185)
• expenses, but that’s not doable right off the bat for the average human being on this planet. However, you will work toward it slowly and methodically—you know, Profit First style. A good starting balance for the Vault is one month’s rent or mortgage payment. If you can spare that right now, transfer it to the Vault immediately. Remember, this account must be difficult to access (e.g., different bank, no online banking, no checkbook, etc.). Once you eradicate debt, the Vault will grow and grow, with the intention of having the cash you save here eventually become a source of income. This is where money makes you even more money. C. RECURRING PAYMENTS Account. This account is for payment of your recurring bills, including fixed (e.g., your mortgage or car loan), varying (e.g., utility bills) and short-term (e.g., an installment plan for your kid’s braces). Determine the monthly average for your varying recurring bills, plus 10 percent. Then total your fixed recurring bills. Add the two totals plus the cost of your short-term recurring bills: this is the amount you will transfer from your INCOME account into your RECURRING PAYMENTS account every month. If you have it, transfer that amount now. D. DAY-TO-DAY Account (multiple, if needed). There are many day-to-day costs in keeping a family running—groceries, clothes, school supplies, Girl Scout cookies, date night, running shoes, Girl Scout cookies, babysitting, toiletries, snow tires, Girl Scout cookies … okay, maybe I’ve had enough of those … just one more Samoa? No? Okay, I’ll stop. Set up a DAY-TO-DAY account for anyone in the house who’s responsible for paying for these types of expenses, and transfer the amount that each person needs every tenth and twenty-fifth from the INCOME account, based on spending requirements. For example, my wife and I both buy stuff for the house—I’m the Costco king; she handles the grocery stores. And we both gas up cars and pay for kid expenses. Get a debit card for each person so that purchases are deducted from the account immediately. (Page 186)
• E. DEBT DESTROYER Account. This account receives all remaining funds and goes toward eradicating debt. Following Dave Ramsey’s advice, make the minimum payment on each debt. Then, regardless of interest rates (unless they are extreme), pay off your smallest debt first. Wipe that sucker out and then move on to the next one. Ramsey wisely says that paying off a debt, however small, creates a mental momentum that will motivate you to pay off the rest of your debt faster. Remember, we are emotional beasts, not logical ones. F. You will have big events in your life, such as buying a house, buying cars, paying for your weddings (likely your kids’ weddings … maybe yours), college, college and yet another kid going to college. Here’s the deal: there are good financial programs out there for this stuff, such as 529 plans. These are just ideas for accounts that you may benefit from and are not mandatory. (Page 187)
• When you realize that 99.99 percent of the people who know you or know of you won’t care what you own or where you hang out or what your circumstances are, and that the 0.01 percent who, for whatever reason, can’t stand you will simply point a finger at you, laugh evilly, and then direct their self-loathing misery at someone else, it’s easier to ditch the pimpedout ride. (Page 190)
• And when you realize that 99.99 percent of the people who do know you and truly love you will rally around your courage, as my family did for me, that, that is when you will stand up, brush yourself off, and say, “Let’s do it.” (Page 190)
• Now that you know your salary and actually take it, you need to live within your means. Then you’re going to lock in your lifestyle. What that means is, no matter how good things get (and this is going to be a challenge for you, because now that you follow Profit First, things will get amazing), you will not expand your lifestyle in response. You need to accumulate cash —lots of it—and that means no new cars, no brand-new furniture or crazy vacations. For the next five years, you will lock it in and live the lifestyle you are designing now so that all of your extra profit goes toward giving you that ultimate reward: financial freedom. (Page 192)
• Here are five rules to help you stay locked in to your lifestyle for the next five years: 1. Always start by looking for a free option. 2. Never buy new when you can get the same benefit you would if you bought used. (It’s used as soon as you buy it anyway.) 3. Never pay full price if you can avoid it. (Page 192)
• 4. Negotiate and seek alternatives first. 5. Delay major purchases until you have written down ten alternatives to making the purchase and have thought through each one. Save your splurging for Profit First quarterly disbursements! Yay! (Page 193)
• Give your kids some mailing envelopes (you know, the snail-mail type) and have them label each one: 1. One for the big dream, like my daughter’s horse. Have them stash up to 25 percent of their chore money in this envelope. 2. One to help support the family. This number should be a recurring number, such as five dollars a week to contribute to groceries or entertainment. The key is to have a recurring fee so they get used to having to pay out something on a regular basis. Make sure the number is age appropriate. 3. One for impact. Have them put 5 to 10 percent into this envelope to give to a charity of their choice, or to use in a meaningful way … like starting their own business, one that both serves the community and makes money! (Page 194)
• 4. One for the Vault. This is where they will sock away 10 percent of their funds for a critical emergency (hopefully your kids will never have one, but you want them prepared from day one), which will also become an investing source as the money accumulates. 5. One envelope for mad money, to buy whatever they need or want—toys, music, books, etc. Let them earn money and have fun! (Page 195)
• It goes without saying that the kids must follow the Profit First golden rule: always allocate the money to the different accounts (envelopes) before doing anything else. This system will teach your kids so much about the value of money—how to manage it, how to earn it, how to finance their dreams. It may feel strange at first (I’m talking to you, helicopter parents), and you’ll surely get some pushback, but this is a massive gift to them. Imagine how your financial life might have turned out differently had someone taught you these important lessons and strategies. Or if you are lucky enough that your parents did teach you, just think about how well it served you and can do the same for your kids. (Page 195)
• TAKE ACTION: LIVE PROFIT FIRST Step 1: Set up corresponding Profit First allocation accounts for your personal expenses. Step 2: Based on your most recent pay and the “lifestyle lock” explained in this chapter, figure out how much you should truly be living on. Step 3: Have a sit-down with your entire family and talk numbers. Tell them what you’re doing with Profit First and the positive impact it will have on your family’s long-term financial health. And if it helps, you can tell the kids that this method was something suggested by “Uncle Mikey.” (Page 196)
• Chapter 11 HOW TO KEEP IT FROM FALLING APART (Page 197)
• Going it alone is the biggest mistake (Mistake #1) entrepreneurs make when implementing Profit First, but there are others. In this chapter, I’ll share a few more pitfalls and how to avoid them as you work the Profit First (Page 199)
• system. Don’t worry—none of my solutions require you to square-dance. (No offense to my square-dancin’ readers.) (Page 200)
• MISTAKE #2: TOO MUCH TOO SOON (Page 200)
• It is extremely common for entrepreneurs new to Profit First to start putting 20 percent or even 30 percent into their PROFIT account right out of the gate. The next month they realize they can’t afford it and pull the money back out to pay bills, which defeats the entire process. You must allocate profit and not touch it, so you’ve got to be sure that your business can handle the reduction in operating income. (Page 200)
• MISTAKE #3: GROW FIRST (AND PROFIT LATER) (Page 201)
• Pick growth or pick profit, but you can’t have both. Bullshit! Profit and growth go hand in hand. The healthiest companies figure out how to consistently be profitable first and then do everything to grow that. (Page 201)
• MISTAKE #4: CUTTING THE WRONG COSTS (Page 203)
• Money is made by efficiency—invest in it. If a purchase will bring up your bottom line and create significant efficiency, find ways to cut costs elsewhere, and consider different or discounted equipment (or resources, or services) rather than sacrifice efficiency for what you think are savings. (Page 203)
• MISTAKE #5: “PLOWING BACK” AND “REINVESTING” (Page 203)
• When you don’t have enough money in your OPEX account to cover expenses, it is a big red flag that your expenses are too high and you need to find a way to fix them fast. Once in a blue moon, it could also mean that you are allocating too much to Owner’s Comp or Profit. This only happens when you start with a high Profit or Owner’s Comp percentage. And when it happens, it is because you are taking a percentage of profit or pay that you are not yet able to sustain; the efficiencies are not yet in place to support your profitability. But again, this is rarely the reason your OPEX account is in the red. (Page 204)
• MISTAKE #6: RAIDING THE TAX ACCOUNT (Page 204)
• As your profitability grows, your taxes will, too. In fact, paying more taxes is an indicator that your business health is improving. Now, I am not saying you should ever pay more taxes than you need to (tax is just an expense like any other), but do realize that your taxes will grow as your business health does. So don’t steal from your TAX account, thinking you won’t need that money for taxes. You will. (Page 205)
• MISTAKE #7: ADDING COMPLEXITY (Page 206)
• I have seen entrepreneurs modify their bank balances by introducing depreciation or amortization of stuff. Don’t do this. Cash is cash. Either you have it or don’t. (Page 206)
• MISTAKE #8: SKIPPING THE BANK ACCOUNTS (Page 207)
• Profit First must be set up to be directly in the path of the natural behavior of you, the entrepreneur. Because you log on to your bank account to look at your balance and make decisions, you must have Profit First there. Spreadsheets and your accounting system’s general ledger reports are also great, but they are also too late. You don’t look at them when making in-the-moment money decisions; you look at them after the fact. Coming up with a battle plan after the battle is over is useless. (Page 207)
• TAKE ACTION: GET REAL WITH YOUR ACCOUNTANT Sit down with your accountant, bookkeeper, or coach (ideally, all three), preferably a PFP trained in this system, and come up with a game plan to ensure that you don’t end up allocating too much revenue to your PROFIT account and you do allocate enough to your TAX account. Schedule quarterly check-ins to make sure you are consistently building up your profit and other allocations while reducing your operating expenses. And if for any reason whatsoever, you have not yet set up Profit First at the bank, for the sake of all that is holy, do it now. Follow the lead of Claudio Santos, who emailed me from South Africa just as I was typing the final words in this chapter and said, “Just started with your book. Can’t seem to put it down. Anyway, just following your instructions and doing what you said.” Claudio opened his account and sent me an email to tell me (Page 208)
• about it, just as I asked you to do in Chapter 1. I strongly suspect he is about to see a positive turn in his profits. That’s it. Just do it. (Page 209)
• EPILOGUE (Page 210)
• As for me, running a Profit First business and lifestyle has given me complete confidence over my own finances and freed me from the endless search for a big payout. I’m no longer looking for the Holy Grail—I don’t need it. I’m not hoping that one day someone will swoop in and save me from a check-by-check business by buying me out. My businesses are profitable today, and they will continue to be profitable tomorrow, next month, and in the years to come. I am debt-free and stringing together one small financial win after another—every tenth and twenty-fifth of the month. (Page 212)
• The normal response to fixing problems is to try to change our habits. In The Power of Habit Charles Duhigg says habits are “click, whirr.” Triggered by something (like an empty bank account)—click—we go into our reactionary routine, like making panicky collection calls, for example— whirr. As Duhigg points out in his book, changing habits is possible but is also really, really hard. Instead, simple systems that capture the good parts of our habits and guard us from the bad parts will bring about positive and permanent change, fast. (Page 212)