What to Do With Debt: Paying Off Debt With Profit First
If you’ve experienced debt in your personal life or your business, you know that it can feel suffocating. Your financial walls are closing in on you, and you’re ready to get rid of it once and for all.
We’ve talked before about good uses of debt vs. bad uses of debt, and there’s an important distinction. But aside from that, we think it’s important to let go of consumer debt and other debt sooner rather than later.
But how exactly? We can and will help you with this. But before we get into our recommendations for conquering debt, we need to lay some ground rules.
Use Your Summer Slow-Down Wisely
As the days grow warmer and people start taking vacations, wellness businesses often take a hit. Therapy slows down and people opt for outdoor workouts instead of the gym.
Hopefully you’re prepared for the financial slowdown that comes with seeing fewer clients. That means having a subscription-based revenue model and having an advanced account that holds your summer expenses for you.
But with the summer slow-down, your time opens up for so many opportunities behind the scenes while still allowing you to keep a steady paycheck. Let’s explore each one of these!
Take Action With Quarterly Profit Distributions
Our favorite time of year happens four times: at the end of each quarter. If you’re following Profit First, this is when you, as the business owner, get to take half of what’s built up in your profit account as a distribution (a bonus, if you will) to yourself.
That’s right, every 90 days you get to share in the profits of your business.
Using Advanced Accounts to Up Your Profit First Game
The big benefit of using the Profit First system is that you pay yourself first. You never have to forego paying yourself because that, and your profit, comes first.
At the same time, there are sometimes other parts of the business that demand your attention. Things like new equipment, large one-time or yearly fees, future investments that you may not even know you need yet.
No two businesses are alike, and each will have its own complexity. So while having the basic five accounts (Income, Profit, Owner’s Compensation, Taxes, and Operating Expenses) is important, sometimes we have other needs too. Thankfully, it’s easy to customize the system to meet the needs of your unique business, by opening additional, “advanced” or “drip” accounts.
Your Guide to Taxes the Profit First Way
If you’re like many business owners, you’ve just closed up your books from last year, sent 1099s, gathered all your tax information, and now you’re staring down the calendar wondering when you’re going to have time to do your taxes.
Sound familiar? No one said taxes was fun but I, for one, am anxious to get mine done as soon as possible. Why’s that? Because I use the Profit First system and I have all the cash I need (and more!) saved to pay my taxes.
Setting Your 2022 Financial Goals
Have you set big, lofty financial goals for 2022? And if so, how did you come up with those numbers?
Setting financial goals is incredibly helpful so you have something to strive for, but setting the right goals is vital. If they’re not realistic, you’re bound to feel frustrated mid-year, throw up your hands and give up.
Let’s avoid that by setting your goals with intention and research. Answer each of these questions and write down any numbers and calculations so you have them handy.
How to Reduce Taxes Without Reducing Net Profits
Everyone likes being profitable, yet no one likes paying taxes. So, how can we reduce taxes without reducing net profit?
Retirement Contributions
Making contributions to your qualified retirement plan (SEP/SIMPLE IRA; Solo 401-K; etc) through your business can reduce your federal income tax, but does not reduce your taxable net profit. The cool and unique thing about this deduction is that the IRS allows you to make retirement contributions beyond December 31, up to the filing deadline of your main tax return, in order to maximize your deduction for the previous year.
Health Insurance Premiums
The health insurance premiums paid on behalf of the owner(s) work very similar to retirement plan contributions: They reduce your federal income tax, but not your business’s net profit. Health savings accounts can be used to achieve the same objective. First, make sure you’re eligible for the deduction. For example, if your spouse has health insurance through their employer and they have the option to cover the entire family, you may not be able to claim the deduction through your business.
S Corporation Conversion
If your small business is profitable (especially beyond $50K/yr) and you file taxes on Schedule C, you may benefit from electing to be taxed as an S-Corporation. This strategy will help you to legally reduce self-employment tax. But be careful when adopting this strategy. Electing to be taxed as an S-Corp comes with increased compliance issues, which means more fees. You’ll have a separate tax return to prepare, and you’ll have to run a payroll for yourself (which will require payroll tax returns). You’ll want to do this with the help of a tax pro. Make sure all of the extra fees associated with becoming and maintaining an S Corp do not eat up what would have been your tax savings.
Non-Business-Related Deductions and Credits
All business owners will eventually end up filing a Form 1040 (the main tax form), and it includes all of the credits and deductions that aren’t business-related. Make sure you are maximizing all credits and deductions outside of the business. They will not reduce your net profit at all but the tax savings can be great.
The main thing to remember about the 1040 tax return is that it includes ALL sources of income, and well as all of the available credits and deductions; not just the business stuff. The popular ones are the student interest deduction, charitable contributions, the Child Tax Credit, Earned Income Credit, etc. Reach out to your tax pro to see which credits and deductions you may qualify for.
How to Talk to Your Clients About Raising Your Prices
You’ve determined that it’s time to raise your prices. How do you communicate this to your clients and customers?
First of all, don’t make it sound like you’re breaking bad news. Raising prices is a natural and recurring step in the life of a service-based business. Know your worth. Get confident and comfortable in your own head of the value that your business provides. If you can’t convince yourself that a price increase is warranted, then you won’t be able to sell it to anyone else.
Obviously, you don’t want to alienate your clients. You want to keep them happy. And believe it not, your clients don’t just want you to survive—they actually want you to be profitable. So this can absolutely be a win-win situation if you play it right.
You especially want to get your long-term clients on board with a price increase. If they’re unhappy, they have the potential to spread their discontent throughout your culture and community of members. This is the kind of water fountain talk you want to avoid happening at your place of business or on social media.
In this post, we offer some suggestions and thoughts on informing your clients about pricing changes. At the end of this post, you can find a link to our pricing increase template letter to help make this task easier for you.
- For starters, always give 30 days notice when raising rates. You don’t want clients to feel like they’ve been rushed or ambushed into a new commitment.
- Put it in writing—at the very least, you should send them an email.
Keep in mind, your clients will view a rate increase relative to the price they’re currently paying. A $6 per month bump might seem like no big deal, but if their membership fee is already $80 per month, that’s a 7.5% increase in price, which may not go unnoticed—especially if they’re currently paying a higher-than-market price for your service.
- Transparency in general can go a long way toward sweetening the news. Explain exactly what you’re doing, why you need to do it, and make it relevant to them. If you made a guarantee to provide a certain level of service as part of their membership agreement and now you need to increase pricing in order to maintain that level? Explain that.
People get attached to their service providers especially in fitness and wellness. They care that they are compensated fairly and have good working conditions and opportunities. So your clients will usually get behind an argument for increasing rates that involves paying their service providers more, or investing in your team in some way. It’s more than fine to get a little personal about this in your email.
As I’ve said recently, I’m in favor of increasing prices regularly by small amounts rather than by large amounts less frequently. Clients are more accepting because they’re likely to see that you’re just keeping up with the rising cost of doing business. But there are times when a large price increase is justified—to you, at least.
- If you’re implementing a small increase for the cost of doing business, say 2 to 3%, amounting to a few dollars more per month, it’s okay to simply inform your clients of this and invite them to contact you with any questions or concerns.
- If it’s a bigger increase, however, it might be a good idea to sit down with your clients one-on-one, or give them a call, in addition to sending an email.
The important thing here is to demonstrate how they’ll benefit from the improved services you’ll be providing with more funds in hand. Even better if you can tie it in directly to how this will help them reach their goals or soothe their pain point.
Maybe you’re going to improve the temperature control in your building so they won’t be chilly anymore while getting a massage. Or maybe you’re adding new equipment so they won’t have to wait in line to use the weight machines, and they can get home faster to their kids on gym night.
- If you’ve been seriously underpriced in the past and now need to get in line with the market, you probably need to be adding more services to justify a very steep increase. I’ve seen a gym membership cost jump from $59 to $100, but they changed their business model to do that by adding new equipment and more programming at the same time, like additional access to coaches and classes.
In general, if you’re not comfortable asking your clients to ride the increase with you, ask yourself if there’s something you need to add in to your services so that you ARE comfortable charging an increase.
And because we know it’s hard to ask for money, sign up below to get a free pricing increase template letter you can use.
Raising Prices Doesn’t Guarantee Increased Profitability
If you’re trying to increase your business profits (and who isn’t?), you might think the sure-fire way to do that is simply to raise your prices. If your customers pay more, you’ll make more. Right? Not necessarily.
Well, if you’re using the Profit First method, raising prices will indeed equate to increased Profit. Because you take in revenue, you immediately pay yourself a profit. So if you take in more revenue (by raising your prices), you’ll pay yourself more profit. But increased revenue does not necessarily mean increased profitability.
Profitability vs. More Profits
And what is profitability exactly? It’s a measure of your profit relative to your expenses. It’s an assessment that helps you determine if your business can sustain itself and grow. Ultimately you want to be able to project the profitability of your business well into the future.
Here’s why raising your prices does not automatically equate to increased profitability.
You do have to raise your prices from time to time no matter what because of inflation. The cost of doing business is always gradually increasing because the costs of goods and services in our economy are generally rising over time.
So if you raise prices just enough to keep up with the cost of doing business, you might not increase your profitability at all. So how do you increase profitability?
There are endless tactics and factors of influence. (Here are just a few ideas specifically for gym owners.)
But at the most basic level when we’re talking about profitability, raising prices alone won’t cut it. You have to raise your prices and you also have to monitor your expenses.
How to Plan a Pricing Increase
Price increase strategy incorporates many factors. Ideally, you have a system in place for reviewing your client pricing structure on a regular basis. This involves running reports and examining numbers that are very specific to your business and its service offerings. Read about one fitness studio owner’s successful formula for profitable pricing here.
But let’s say you’re leaving your pricing structure in place for now because it’s working well. How much should you raise your prices, even if just to stay even with current expenses?
I’m always a proponent for increasing your prices regularly by small amounts rather than implementing larger increases less often. It’s easier for clients to stomach.
At minimum, we suggest increasing your prices by 1 to 2% annually to account for an inevitable increase in the cost of something or other. But a 3 to 5% increase is very standard.
Your landlord might raise the rent, or the cost of your CRM software monthly subscription might go up—or both. You might be able to predict how much your vendors will raise their prices this year by reviewing the history of previous years.
And then consider whether you need to upgrade to a higher tier of an existing expense, or purchase something new altogether this year. You’ll need to factor that into your spending plan, and possibly your pricing increase, if you haven’t saved ahead to pay for it.
You should examine your full roster of expenses at least quarterly, and definitely whenever you’re thinking about implementing a pricing increase. We talked about analyzing your recurring business expenses and how to reduce them in this earlier post. Trim whatever you can. This is a step toward increased profitability.
Along with that, you should look at any other areas where you may have inefficiencies in your business. Are you running a tight ship with your team members for maximum productivity? Trim here too, if necessary. Labor inefficiency is an enemy of profitability.
Raise Prices to Achieve Broader Goals
Now you’re aware that you need to increase prices incrementally on a regular basis just to keep up with rising costs. Of course, it’d be great if you also could strategically raise prices to help you achieve your broader business goals.
For example, do you have a goal to pay yourself more every month? You can use a pricing increase to take an incremental step toward that. Work backwards with the numbers. Do you know what your revenue needs to be in order to increase your Owner’s Pay by as much as you want to? Figure out how much you need to increase incoming revenue per client in order to make that incremental step.
Final Thoughts
Overall, determine an increase that you are comfortable selling to your clients. Are you confident that a $10 increase in their monthly membership fee is worth it for them?
Part of raising rates and your journey toward increased profitability might also involve changing your business model to add more value to their membership. If your goal is to have a higher market share (more clients), then you’ll naturally need to scale your business over time to accommodate them.
Having a higher market share also makes you a more competitive business, and this alone can improve profitability.
And stay tuned for next week’s post, where we’ll offer some best practices for how to tell your clients that prices are going up!
Your Black Friday Deal Probably Needs a Drip Account
Did your business promote a Black Friday deal this year? If so, now’s the time to set up a Drip account within your Profit First system—before you spend the revenue that you made.
What’s a Drip account?
It’s an account you create to help you manage the cash flow when you receive a lump sum payment instead of installments for a service or offering that you’ll be providing to your clients over a long period of time.
Maybe you’re selling a discounted annual gym membership to customers who pay upfront for the year in full. They’ll be using your facilities and your resources over the course of 12 months and your expenses to service them will be accruing over that same period of time. So it doesn’t make sense to treat their full payment as money in your pocket now.
Instead, stretch their payment out over 12 months even though you’ve received it all at once. The sensible thing to do is to place the revenue in a Drip account, then take a proportional amount of the money and “drip it out” each month. So you’re matching revenue with expenses on the same timeline.
If you don’t allocate this money correctly, then it’s just money without a plan, and you’re in danger of spending it. We see this a lot: businesses in year-round “Black Friday mode,” trying to sell annual memberships, or offering other long-term, one-time payment deals, because they’re always needing a large influx of funds—to pay for services they sold months ago but don’t have the resources to cover now.
As one of the biggest spending days of the year, Black Friday is a classic time to offer special membership or subscription deals. But your business should use a Drip account for any similar payment structure regardless of the time of year. Retainer fees, sales of packages and bundles, pre-payments—these all might warrant the use of a Drip account.
Here’s an example of how to use your Drip account for annual membership fees paid in full up front.
- Put each lump sum payment into the Drip account.
- Automatically transfer 1/12 of the amount to your Income account every month as if you just received the revenue (in two payments on the 10th and 25th as per the suggested Profit First schedule would be great).
- Proceed as you normally would to allocate the funds by percentages—into OPEX, Owner’s Pay, Profit, Tax, Payroll, and any other advanced accounts you’ve created within your Profit First system (the Drip account is considered an advanced account as well!).
Of course, if the membership deal is six months instead of 12, or if it’s an unlimited package deal for three months, then you’d prorate the funds accordingly. You might need to create multiple Drip accounts if you have multiple levels of deals on offer. You can also book a call with a professional to help you determine how much to drip each month.
Trust the Drip account system.
Don’t be tempted to move more than 1/12 of the Drip account funds into Income every month. Can you see how you will end up overinflating your Profit First accounts? OPEX will definitely be too high, and you will mistakenly think that you can spend more on expenses—which could topple your whole Profit First system.
With Owner’s Pay, this inflation can be especially dangerous. If you’re an owner who withdraws the full amount from your Owner’s Pay each pay period, you’ll be paying yourself prematurely for services not yet rendered. (And you know we advocate for building a buffer in Owner’s Pay. Determine a living wage for yourself and withdraw that every month, leaving the extra for when tough times hit. True, Owner’s Pay will grow as your revenue increases, but you should be making calculated decisions to increase your Owner’s Pay allocation percentage using accurate earned income figures from previous periods.)
Similarly, you might think the Drip account should only be for setting aside some OPEX monies, and you can do what you want with the rest. Which would be…? Putting it in Owner’s Pay? Or Profit? You can see how you run into the same problem.
Black Friday shouldn’t put you in the red.
When you do offer long-term, prepaid deals, you need to price them appropriately to cover your expenses that will accrue over time. You’ll probably need to pay yourself or a team member to work with the client, so factor in payroll expenses. Don’t forget rent, utilities, insurance, and anything else that falls under OPEX.
You may think of offering deep discounts for existing services to get people to sign up. But consider how you can add value to your product offering instead of discounting the price. Throw in a free month of a nutrition app with the purchase of a gym membership, or add a free massage for buying a bundle of ten at full price. We’ve encouraged you to get creative to incentivize your clients in an earlier post.
We caution you against relying too heavily on “paid in fulls” to sustain income. Monthly recurring revenue models are much easier to manage in terms of cash flow. As you head into the new year, what are some ways your business can create excitement around a monthly subscription rather than waiting for the next Black Friday to roll around?