Profit First: A Billfold Book Review

Last week, I interviewed Oh My Dollar! CEO Lillian Karabaic, who said she was running her business using a modified version of Mike Michalowicz’s Profit First system.

I immediately put a library hold on Michalowicz’s book: Profit First: Transform Your Business From a Cash-Eating Monster to a Money-Making Machine.

And, this weekend, I read it.

At its core, the Profit First system looks a lot like the system I use: instead of paying your expenses and saying whatever’s left over is “discretionary” and anything left over from that is “savings,” you pay yourself—and your profit—first.

I put 25 percent of my gross freelance income into a taxes account and 15 percent into a savings account, and run my life and my business on the remaining 60 percent. Michalowicz suggests dividing income in a similar way. He explains how to determine your own percentages in the book, but here’s one of his examples:

  • 10 percent to PROFIT
  • 10 percent to OWNER’S COMPENSATION
  • 15 percent to TAXES
  • 65 percent to OPERATING EXPENSES

You can see right away that these percentages assume a certain type of business: first, it’s a business with a lot of operating expenses; second, it’s earning enough money that you can live on 10 percent of its gross revenue. My freelance business works the other way around; I spend roughly 10 percent of my gross revenue on my business, and live on 50 percent of what I earn.

Except sometimes I live on less than 50 percent of what I earn, because I’m spending more than 10 percent of my freelance earnings on business travel or book publication. That’s where Profit First urges business owners to take a good look at their business expenses and start cutting back.

If your business does not make a profit while allowing you to live on a modest salary, Profit First argues, you are doing something wrong.

First, a note on “modest salary;” Profit First suggests living the frugal life—there is the ubiquitous advice to ditch your Netflix subscription—so you can afford to live on 10 percent of your business income. The wealth will eventually come through your business’s profit, which will steadily grow as long as you pay profit first.

Also, it’s time to get rid of that debt, whether it’s personal or business related. Michalowicz, for example, funded part of his expense-and-debt-reduction process by selling his three luxury cars.

That’s my biggest criticism of Profit First, and it’s something I see in a lot of personal finance texts; the author often assumes we have big-ticket items we can sell or other ways we can immediately downsize. For example:

I made it my mission to get what I needed for my business on the cheap and took pride in doing so. My office space cost a mere $1,000 per month—peanuts compared to my previous $14,000 a month digs. I got my gently used conference room furniture for a whopping 75 percent discount. My dry erase board was homemade, with white board material used to make showers, dental floss, and some car wax. (Top that, MacGyver!)

He was able to save $13,000 per month by moving to a $1,000-per-month office! That’s admirable, but it’s the type of advice that isn’t necessarily applicable—otherwise, trust us, we’d reduce our rent by 93 percent as well. (In my case, I’d need to run my home office out of an apartment that rents at $70 per month.)

When Michalowicz wants to cut back even more, he leases the $1,000-per-month office and gets free office space from a friend. He also drops his gym membership but still goes regularly to the gym on his friend’s guest pass, which reminds me a little bit of Claire Rudy Foster’s article on the cost of working for your friends:

Some of my friends became successful, or at least stable, using this approach. What I didn’t realize, until I started to ask questions about their business models, was how much of their business was actually built on the assumption of free or severely discounted labor. They didn’t budget for marketing, administrative help, or other business support. They all knew someone who offered those things, and might be willing to do them for free.

But hey, if you can’t downsize from a $14K office to a free office, you can always cut that Netflix subscription!

Criticism aside, I think the Profit First methodology is really strong. Allocating chunks of your income before you spend it, and then making do on what’s left, has worked for me—and I suspect if I had a larger business that had more operating expenses and needed to earn both a profit and multiple employee salaries (including my own), Michalowicz’s formulas would work out really well.

Even the idea that “if you want to earn a specific profit, start saving that profit now and run your business on what’s left over” holds up, at least in my personal experience. Michalowicz suggests setting income goals, which I have done, and hustling to make those goals, which I have definitely done. If you know how much money you want in your bank account (or your profit account) at the end of the year, working towards that number and saving it first is a lot smarter than “hoping there will be exactly that much left over.”

Of course, your business has to be earning enough for all of this in the first place—and that’s the other area that the book doesn’t really cover. Maybe your business is failing not because you’re spending too much, but because you’re selling something that nobody wants to buy. To be fair, Michalowicz has already written a book on how to grow your clients and sales, which he references multiple times as a supplementary resource: The Pumpkin Plan: A Simple Strategy to Grow a Remarkable Business in Any Field.

And yes, I’ve already put a library hold on a copy.

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