Learn to Adapt the Profit First Method for Online Solopreneurs
If you’re a “bank balance budgeter,” you’re going to love this.
Money management is a touchy subject for some people, but it’s also something that we all need to be talking about! Cash flow is the lifeblood of small business, so we’re going to start treating it as such.
Today, I’m going to walk you through a revolutionary system that is guaranteed to change your financial story when implemented correctly. But I’m also going to show you how to take a generalized system made for traditional businesses and make it work for digital entrepreneurs like you!
Let’s talk about Profit First and how to learn to adapt the profit first method for online solopreneurs.
What is Profit First?
Profit First is a money management system (and a book, which I recommend you read!) developed by small business finance expert Mike Michalowicz. The system is defined by two main principles: profit first and allocation of income.
What does profit first even mean? Mike teaches us to prioritize our profit before paying any of our expenses. Traditionally, we take our income, subtract our expenses, and name the leftover “profit” (if we’re lucky enough to have any).
Income - Expenses = Profit
However, Mike suggests we flip the script. We take our income, prioritize a percentage for profit, and take whatever’s left and use that to pay our expenses. If there’s not enough, we have too many expenses and need to make cuts!
Income - Profit = Expenses
Allocation of Income
So how does someone practically adapt the profit first method? That’s where the second principle comes in: you allocate your income as it comes in!
Profit First teaches us to take all the money that comes into our business and allocate it out to four different categories based on predetermined percentages:
Profit - This acts as an emergency cash cushion, but you also get to pay yourself 50% of whatever has built up in this category every quarter as a bonus! It’s your reward for running a profitable business! Traditional benchmark: 5% of gross revenue
Tax -Save up for your income tax liability. Always consult a tax professional for an accurate assessment of your personal situation. Traditional benchmark: 15% of gross revenue
Owner’s Pay - A fund to draw a regular salary from. If there’s more money set aside than your salary, you leave the rest! That’ll go towards your next paycheck. And, voila! Consistent, reliable income from your business. Traditional benchmark: 50% of gross revenue
Operating Expenses - This goes to paying your regular operating expenses and additional investments you make for your business (hello coaching, courses, and new office furniture). Traditional benchmark: 30% of gross revenue
So, wow, that’s a lot. How do you keep track of everything?
Traditional Profit First teaches that you should have [at least] five separate bank accounts for each category: Income, Profit, Tax, Owner’s Pay, and Operating Expense. Twice a month, on the 10th and 25th, you’ll zero out the Income account by transferring the funds into the other four. This is definitely an easy, visual, and tangible way to organize and track your Profit First funds.
But, now that we’ve covered the basics of traditional Profit First, we’re also going to talk about ways that an online solopreneur might tweak this system!
Why Do We Need to Adapt?
Some of you may be thinking, “That system up there seemed pretty foolproof, why would we change anything?”
My first response is, we don’t have to. The above is a completely valid and functional system, and you can 100% follow it as is.
However, Profit First, the book, was originally written with more “traditional” brick-and-mortar businesses in mind. Plus, it’s written towards a larger category of business owners. Mike himself says in the book that the term “small business” encompasses an extremely large range of businesses!
For example, according to the Small Business Administration’s 2016 Size Standards, any business in the “Internet Publishing and Broadcasting and Web Search Portals” subsector with less than 1,000 employees is considered a small business.
If you’re an online solopreneur, you know as well as I do the incredible difference between a one-woman-show on the internet and a digital company with 999 employees. Talk about vague.
Which is why I like to approach every business’ Profit First implementation with a flexible mindset.
Not everyone is going to find separate bank accounts practical.
Not everyone is going to need to save 15% of their gross revenue for taxes.
Not everyone is going to want to wait until the 10th and 25th of each month to allocate their income.
So, in order to successfully CHANGE a system that promises a 100% guarantee to everyone who uses it correctly, we need to make sure we understand why Profit First is so successful. Otherwise, we risk negating the whole process!
What Makes Profit First Successful?
I believe Profit First is successful because of three characteristics: Intention, Allocation, and Organization. If we can make sure we carry these forward, we can make a system that works for us!
By setting profit aside first, as well as owner’s pay and taxes, you’re intentionally making room for the critical items that we often forget about when we’re signing up for a new payment plan.
While profit and tax are obviously essential, one of the most important elements here is the owner’s pay! As entrepreneurs, we’re often guilty of sacrificing our own paychecks when cash gets tight. But when you do this, you’re asking for burnout. If your business isn’t serving you or rewarding you for your hard work, it will begin to feel like a burden!
Part of intentional money management, like the Profit First method, is making sure that all necessary areas are being served and fulfilled - including you.
When we adapt the Profit First method, it forces us to look those responsibilities in the eye and see exactly where we need to assign our funds. It allows us to proactively manage our money, not just wait and see what’s leftover at the end of the month so we can do damage control.
Our system needs to allow us to be precise and intentional with our money’s various jobs.
Putting intentionality into practice, Profit First involves a system of allocating the money that is already in our bank account.
Notice that we haven’t talked at all about projecting income and making a budget off of that. That’s old-school budgeting and it’s extremely ineffective for solopreneurs with variable income.
Profit First is a cash management system - no guesswork necessary. When the money enters our bank account, we allocate it out into different funds. It’s tangible, it’s visual, and it allows us to be more accurate than we would be with projections. This is what our “new” system needs to accomplish.
And finally, we need a system that allows us to stay organized! The Profit First method seeks to accomplish this with physical bank accounts. This appeals to the entrepreneur who is guilty of “bank balance budgeting” - meaning you make spending decisions based on whether or not there’s a positive number in the bank, without necessarily knowing if you’ll need that money elsewhere.
A huge element of the success of the Profit First method is the separation of funds so that they can do their jobs - and that means that you can’t intentionally or unintentionally steal from another category. No self-sabotage allowed!
This is why the bank accounts work so well! You’d have to deliberately sit down and initiate a transfer between accounts in order to steal from yourself (or the government, if you dip into the tax savings!), which can be an effective deterrent for rash decisions.
So, if we’re not going to use the bank accounts, we’ll definitely need to be able to guarantee an equally effective system!
Side note: If you like the idea of separate bank accounts, totally go for it! I used it myself for months and loved it!
How Can I Adapt the Profit First Method For My Business?
Hopefully, you now have a very clear understanding of what Profit First is and why it works so well.
So what can we change about it? That depends on what you need! The two main ways that I adapt Profit First is in the organization of the funds and the allocation percentages for income.
Organization of Funds
When I began using the budgeting app You Need a Budget (YNAB), I learned very quickly that my separate bank accounts were a bit redundant.
Why? Well, YNAB functions like a virtual cash envelope system! If you imagine cashing out your paycheck and allocating funds to different jobs by placing them in envelopes with different labels (such as rent, electric, groceries, fuel, entertainment, etc.), that’s what I’m talking about.
YNAB works by enabling you to “label” every dollar that’s in your bank accounts. So where I would have seen $2,600 in my bank account, I actually see that $390 is set aside for tax (read that as some of the money in my account doesn’t belong to me!). So if I were planning to write a check to, say, a website designer for $2,400, I’d be dipping into the government’s money - yikes.
And something like that could definitely come back to bite me next tax season!
As of this writing, I have yet to find another tool that I trust enough to replicate the effectiveness of the Profit First bank accounts! YNAB is the best!
The other way we might “bend” the Profit First system is with the target allocation percentages.
For example, traditional Profit First teaches us to target approximately 50% of gross revenue for paying yourself and 30% for operating expenses. But maybe that doesn’t work for you!
If you make $4,000 a month with your business, that would mean paying yourself $2,000 and spending $1,200 on business expenses.
But maybe you need to hit a $2,400 salary in order to replace your day job paycheck! Take a look at your expenses. Can you comfortably keep them under $800 instead?
A lot of digital entrepreneurs may find that yes, yes they can! The beauty of online business is lower overhead, after all. So sure, instead, you’ll allocate 60% to owner’s pay and 20% to operating expenses - because you can.
The key is to know your numbers so that you can make executive decisions like this! You want to know how much money you need to be able to pay yourself, you need to know what your tax liability will be next year, and you need to know how much money you actually need to run your business each month.
This is where having a dedicated bookkeeper comes in real handy!
You can also check out my author bio for a link to a calculator that will help you determine both your ideal and current allocation percentages for your new money management system!
Learning how to adapt the profit first method is a life-changing system for so many entrepreneurs. Emphasis on life. Having an intentional and effective money management system will change your whole life, no doubt about it.
My hope here is that you can see what the system is, why it works, and how it can start to work for you.
And the best part? You can get started today.
Even if you choose to use separate accounts and you need time to get those set up at your bank, you can temporarily makeshift your first allocation on a piece of paper if you need to! (I definitely don’t recommend maintaining this system, but there’s no reason why you can’t do it right now.)
Write down your current business bank account balance. Try assigning the funds based on the standard percentages and see where you’d be. If you realize you don’t have enough to pay your upcoming expenses, make some adjustments to meet yourself where you’re at now.
And then make a plan to improve things tomorrow!
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Katie is an accountant-turned-entrepreneur who loves being creative as much as she loves a good spreadsheet. Her mission is to remove the risk and uncertainty of self-employment income and teach purpose-driven digital entrepreneurs how to build a profitable business that serves the life of their dreams. She specializes in the relationship between business and personal money management, helping the two to work together! She’s also known for being a nap lover, buffalo wing addict, and overly-obsessed dog mom.