Set Yourself Up for Success in 2022 with Profit First

It seems like it was just yesterday that we couldn’t wait to put 2020 behind us. And then it was hard to know what to expect from 2021. 

But things are generally looking up for the fitness and wellness industry. As consumers come out of isolation, they’re having a newfound appreciation for the in-person activities and services we provide. And they’re adjusting to a new normal and forming new habits. Now more than ever, physical and mental health is a life priority for so many people. 

So while business owners had to do a fair amount of winging it these past 18 months, next year looks to be more predictable—and hopefully, more profitable. Have you started to plan for financial success in 2022 yet? Profit First is key to this (but you knew we were going to say that).

If you’re already using Profit First, this final quarter of the year is the time to set annual goals and quarterly target allocations for 2022. Trust us, goal setting leads to growth and profit gains. Skip ahead to read our advice on how to do this—it’s a combination of big picture thinking and number crunching, and we’re always here to help.

If you’re a Profit First newbie (or just need a refresher), start here.

If you haven’t implemented Profit First yet, now’s the perfect time to set up your system so that it’s in place and ready to go at the start of the new year. This is exciting! You’re about to pump some new life into your financial health.

Begin by downloading our Profit First Overview. This includes super simple steps—and a formula using your current business numbers—to get started right away with this cash management system. 

The gist of Profit First is in its name. With this system, you will take out a profit from your revenue as it comes in, first. You’ll also set aside portions of your revenue for an owner’s salary, and for taxes (which, let us remind you, become unavoidably due). You will use what’s left—and only what’s left—for your operating expenses. 

With Profit First, you move money into separate bank accounts earmarked for Profit, Owner’s Pay, Taxes, and Operating Expenses (OPEX) so that you cannot be tempted to “borrow” from them. You do this on a regular schedule, usually twice a month.

How much of your incoming revenue should you allocate to each bank account? Profit First works with allocation percentages—so when your revenue goes up or down, all of your accounts will adjust in proportion, as they should. See page 8 of the overview to calculate your suggested target allocation percentages for each account (and what that translates to in real dollars) based on your actual business numbers. The target allocations are just that—targets to aim for, to get your business running optimally. 

This is an excellent place to start, but this is also the place where some business owners get stuck—say, when they’re comparing target allocation percentages with their current figures. Maybe you’re currently spending 50% of your revenue on expenses, but your Profit First instant assessment suggests you allocate just 30% to OPEX. As it is now, you never have enough to pay the tax bill when it’s due, let alone give yourself a profit—so you know you need a better system. But it’s a gradual process to make this shift. You may not be able to make such a drastic cut to your expense budget overnight. 

That’s okay. As Profit First creator Mike Michalowicz says, “The key to successful Profit First implementation lies in stringing together a series of many small steps in a repeating pattern.” This is where a Profit First professional can really help. We’ll do the calculations and show you how you can move from your current allocations to your target allocations, incrementally. Small steps.

And that’s why we suggest setting up Profit First now in preparation to start using it in 2022. Because it does take a few months to get into the habits that make the system successful. So give yourself a quarter to get going. And you’ll refine and adjust the target percentages quarterly moving forward, to get you closer to the ideal setup for your unique business.

If you’re experienced with Profit First, it’s time for annual goal setting and refinement.

Every year I set a new financial goal for my business. You should too. For example, it could be to increase my revenue by 50% in 2022. Once I’ve set a big picture goal like that, then I’ll apply it to my Profit First system already in place. I’ll calculate how much additional revenue I need to be taking in every quarter to reach my goal. And as my revenue shifts, I might need to reassess my target allocation percentages, per Profit First. What do I want my target allocation percentages to be for every quarter in 2022, to achieve the business growth I’m looking for by year’s end?

Then it’s a matter of knowing the data that’s unique to my business, so I can figure out how I’m going to actually get there. What’s my average revenue per client? How many new clients will I need to add at that rate to achieve my goal? 

But it’s not just the incoming revenue. I also must consider what I might need to spend from OPEX in order to acquire those new clients. How much marketing do I need to do to get new business leads, and what will that cost? Will this process divert labor from my team that I need to account for? 

If you intend to plan for business growth and not just wish for it, you should get familiar with the ins and outs of your business at this level. Make 2022 the year you can answer all of these questions.

As you can probably see, planning for success requires a bit of reverse engineering. You set a goal, you do the calculations, you identify the steps, and you take action. It’s often a process of trial and error. Profit First is great because you can build your goals into the system of target allocations and continually customize it for your business. It’s a constant refinement.

So what’s your goal for next year? With some thought and planning (and Profit First), 2022 can be your most successful year yet.

What You Need to Do NOW to Prepare for Tax Season

While income tax filings have an annual deadline, the management of your taxes is ongoing, especially as business owners. 

The key to managing your tax taxes is Proactive Tax Planning. This can mean many things to business owners, depending on the size and complexity of your business. But for the sake of keeping things simple and pragmatic, we’ll refer to proactive tax planning as a periodic review of your financials and projected tax liability DURING the tax year. This allows you to forecast your potential tax liability and position yourself to maximize any credits or deductions you may qualify for. This is the best way to make sure you’re paying the least amount in tax that you’re legally obligated to pay. But what does this look like in practice?

What you SHOULD have been doing (from January to September)

It is currently the beginning of the 4th quarter in 2021 (early October). If you were actively managing your taxes throughout the year (with the help of a tax pro, of course), you will have done these things:

• Know your tax liability for the previous year—This number is the basis for what you may need to pay as quarterly estimated taxes. 
• Pay your quarterly estimated taxes—If profitable, you should have been paying quarterly estimated taxes.
• Review your financials on a monthly basis—You should know if you are more or less profitable as you were this time last year. This will give you a strong clue if you should increase or decrease your quarterly estimated tax payments. 
• Review your financials on a quarterly basis with your tax pro/advisor—They will help forecast your tax liability, identify any tax savings opportunities, and help you make your estimated tax payments. 
• A-la-carte consultations—Between quarterly consultations, you should have reached out to your tax pro before making any major decisions that will have a large tax consequence, like real estate or large asset purchases.

What you should do for the rest of the year (from October to December)

One of the biggest benefits that we have as business owners is the ability to control how much our businesses are taxed. How? By controlling how profitable we are. But we can only exercise that power by having up-to-date financials (a profit and loss statement and balance sheet). 

You can’t know what your tax liability will be until you close out your books after December 31. This is why they call it ESTIMATED taxes. However, by having accurate financial statements, we can make very accurate projections of what you may owe. And by knowing how profitable you are as we near the end of the year, you have the ability to increase or decrease business spending, which ultimately gives you great control over what you’ll be taxed on. 

There’s one popular, yet horrible strategy that I want to warn you against. There are accountants and “advisors” who will encourage business owners to sped off all of their profit in order to save on taxes. This is equivalent to spending $10 to save $3. It’s not illegal, but it’s just a bad strategy if you’re looking to build wealth. Instead, you want to focus on increasing PROFIT while budgeting for and minimizing your tax liability.

So, here are the things you’ll want to do for the remainder of the year:

• Have all of your financial statements cleaned up and updated ASAP if you haven’t done this already. You cannot plan for taxes effectively without accurate financial statements.
• Compare January through September 2021 to January through September 2020. Are you more or less profitable than the year before? This will give you a large clue if you should anticipate a larger or small tax bill.
• Consult a tax pro. Have them do tax projections and forecasts based on your year-to-date Profit and Loss Statement, and based on what you think your net profit will be at the end of the year. Have them identify any potential tax savings opportunities.
• Pay your quarterly estimated taxes if you haven’t done so yet. It’s important to pay 2021’s taxes with 2021’s dollars.  
• Plan to meet with your tax pro before the year ends and keep a really close eye on your net profit as you approach December 31. 
• Catch up on your quarterly estimated taxes if you haven’t done so yet or start planning for it. You should have very accurate estimates if you consulted a good tax pro. If not, use last year’s tax liability as your basis. 

Profit First has a wonderful system to help keep sufficient tax reserves. It’s simple, painless, and can help make sure you have enough for taxes, no matter how little or how much you make. Sign up now for an assessment and let’s get you started!

Having A Plan For That “Extra” Money in Your Profit First Accounts

When a client tells me they’re finding “extra” money in their Profit First accounts, I get excited for them, but also a little concerned.

Excited because more money in their accounts usually means their revenue has increased. Business is probably going well.

Concerned because—well, remember when we explained Parkinson’s Law? The demand for something expands to match its supply. It’s a phenomenon of human behavior that proves itself time and time again. As it applies to money, here’s what happens: The more money you have, the more money you will spend. 

So, for example, when you have “extra” money in your OPEX account after you pay the bills, your natural tendency is to think that’s money that can—or even should—be spent. You may drum up reasons for ongoing expense spending without thinking through if it’s feasible in the long term.

You’ll spend it, and then you’ll form habits of spending. 

Money Without a Plan

When you accumulate more funds than you’d anticipated having thus far in your Profit First accounts, please don’t think of that money as disposable cash. It’s really just Money Without a Plan, which is a bad thing. You should always have a plan for what to do when your revenue shifts. 

The beauty of Profit First is that you can build and tweak your plans through your allocation percentages. You already know you should review them on a quarterly basis, which is fine for the most part, but sometimes revenue has grown so much that you need to make an intermediate adjustment. Here’s what to do whenever your business has more money in its accounts than you planned for. (It might be time to make some new plans.)

Got extra money in the OPEX account?

The most dangerous place to have extra money is in OPEX. There are many options and ways to spend money on things that fall under operating expenses—it can be tempting. 

But remember that Profit First is based on circumventing Parkinson’s Law. Your OPEX allocation should be set up to just cover your current operating expenses so there’s no extra money hanging out in there. 

You can give yourself a little buffer though. What’s the minimum OPEX balance for your comfort level? It might be $100 or $500 or $1000, or one month of expenses. Consider that figure your “zero.” At the end of the month when all the bills are paid, if you have substantially more than your zero in OPEX, then you need a plan for that “extra” money.

What would best serve your business? It might be time to adjust your Profit First allocations to reduce the percentage going into OPEX and to drive them closer to your target percentages for the Owner’s Pay or Tax accounts. 

Or, maybe it’s time to create an advanced account or two within your system. Reallocate some OPEX funds into its own separate bucket for an Annual Expense account, or a Marketing account… It all depends on your business needs. 

Extra money in OPEX almost always means that overall revenue has increased. But it can also mean you’ve cut your operating expenses. Usually that’s part of a plan too, so your allocations should be adjusted accordingly. 

Got extra money in the Tax account?

Let this money accumulate until you’ve paid the taxes for the current period. Repeat: don’t do anything with this money until you’ve paid your taxes! 

Once that’s done, you can transfer the extra funds to your Profit account and withdraw them as a profit distribution when the time comes. Or you could add the funds to an advanced account you’re working to build up.

If you’re finding extra money in the Tax account even though your revenue hasn’t substantially increased (or nothing else has dramatically changed), this could indicate that you may have been a little off in calculating your Profit First targets the last go around. The percentage allocated for taxes should result in the right amount of reserves you’ll actually need, because it’s based on your total revenue. 

If it’s not making sense to you, seek the guidance of your Profit First coach or tax professional before adjusting your target allocations. 

Got extra money in Owner’s Pay?

Good. This is one time when you need a little “extra” in there, or else freaking out may ensue. The pandemic has taught us that it’s so important to still be able to pay yourself when revenue dries up in turbulent times. 

As with OPEX, you can decide on a comfort buffer. For some owners, it’s one month’s pay. But we recommend saving a cushion of three months. It really depends on your personal financial needs. Talk to your Profit First coach for guidance on the buffer and how long to keep it in your account—it’ll be different for every owner based on your overall financial health. 

If you’ve accumulated more than three months in Owner’s Pay, think about increasing your monthly pay disbursement, or adjust your allocations to put more money in Profit and use it to work toward building a rainy day fund or retirement plan. Realize that anything in Profit is still owner’s pay, but sometimes it’s how you label the funds that can determine how wisely you spend them.

Got extra money in the Profit account?

No one has ever complained that having extra money in their Profit account was a problem—go figure. But let’s say you’ve taken your regular profit distributions, you’ve paid off all your debt, you’re jetlagged from enough vacations… and you’ve still got extra profit that you don’t know what to do with. This is the moment to put your profits to work for you, by venturing into investments and retirement planning, if you haven’t already.

However, this is assuming you’ve already got three to six months of revenue sitting in a VAULT account. This is the ultimate disaster preparedness plan for your business, and if you’ve got more Profit than you know what to do with, then you’re surely in good enough shape to be amassing a VAULT.

Now that you have some ideas about what to do with that “extra” money, we’re feeling relieved.

Don’t hesitate to ask us for help in designing a plan at any stage of your business journey. This is exactly what we do.

Who is on Your Business Money Team?

There can be a lot of confusion around who should be on your business money team and their roles (including your role as the business owner). But without a solid team, you may feel confused about your finances–which is never a good feeling.

No matter how long you’ve been in business, it’s time to pull together your team now or revisit the individuals who are supporting you.

Your “Accountant’s” Role

The term “accountant” is broad and is mostly misused by business professionals. For this article, we’ll limit it to the role of tracking your business’s finances and producing accurate financial statements with them. Think P&Ls, balance sheets, reconciliations, and all of that good stuff. 

At a basic level, a bookkeeper will focus more strictly on recording your financial transactions. An “accountant,” however, can give you insight into your financials to help you make strategic decisions. Newer or smaller businesses may suffice with a bookkeeper initially but may have to hire an accountant as the business grows and becomes more complex.

Oftentimes, it’s not the best use of the owner’s time to keep the books. However, you still must understand how to read your financial statements and conduct your financial affairs in such a way that it’s easy for your accountant to track everything (i.e. no commingling of funds between personal and business accounts). Also, if you don’t understand your financial statements and don’t review them regularly, you may put yourself at risk of being stolen from. You want to find an accountant with the heart of a teacher, who will help you understand your financial statements.

Your Tax Pro’s Role

Business owners often think that all accountants prepare taxes. This is not true. Tax and accounting (bookkeeping) are two processes. The accounting needs to be complete before the taxes can be prepared. When seeking out a tax pro, find someone with the heart of a teacher (see a recurring theme there?) who will explain to you how to minimize your taxes and stay in compliance with the IRS and state. If you really want to save on taxes, you’ll meet with your tax pro on a quarterly basis, but definitely at the end of third quarter as you near year-end. Proactive tax planning is the best way to keep taxes low and to ensure there aren’t any surprises come tax time.

You can make your tax pro’s job easier by having accurate and complete P&Ls and balance sheets. Your accountant actually does the heavy lifting in this regard. Be sure to ask your tax pro about any tax savings opportunities or recent changes in tax law that might affect you (a great tax pro will tell you before you ask). Last, make sure you pay your quarterly estimated taxes to the IRS and the state.

NOTE: If your tax pro encourages you to spend off your profit to reduce taxes, seek a different tax pro.

Your Cash Flow Management Coach

We can’t talk about money teams and neglect to mention Profit First Professionals! While accounting tells you where your money came from and when (via financial reports), cash flow management directs where your money goes. We use the Profit First cash flow management system to help business owners become permanently profitable, pay themselves regularly, reserve for taxes, and know exactly how much they need to budget for their business’s expenses. A Profit First Professional can help you design a system that works for your business and your goals.

Contact a Profit First Professional Firm (that’s us!) to do an assessment of your finances and build out a customized cash flow strategy for you. If you contact us, we’ll give you step-by-step instructions.

Last Thoughts

Accounting, taxes, and cash flow management are different disciplines, although closely related. There are some professionals who can do all three, but it’s probably best if you separate some of it out to protect yourself and your money. But all the members of your business money team should be in some type of communication with each other. Just make sure that they are familiar with your business, your industry, or goals, and have the heart of a teacher.

How Profit First Can Help You Talk About Money

As a bookkeeper, I’m always taking the pulse of a business to help assess and improve its financial health—ultimately, so that the humans behind it can have all they want out of life. I talk about money a lot because it’s—no pun intended—the currency I deal in. But it never fails to surprise me how uncomfortable most people are to discuss money, be it their desire for it, their lack of it, or their fear of losing it. Why are we so afraid to talk about it honestly and openly?

Money itself isn’t good or bad. Money is just a thing we use to transfer energy back and forth between people. It’s a medium of exchange to get what we need to live—and then, hopefully, to experience our best lives.

It drives me crazy that money is such a taboo subject, but I get it. I see people ashamed that they’re not providing enough for their family, or that they’re in too much debt, or that they can’t afford what other people can afford. There’s also the hesitation to be proud of financial successes. You’re seen as bragging if you’re doing well.

The truth is, we usually don’t know the whole story behind everyone else’s finances, and we get everything out of whack when we set up comparisons. It’s not apples to apples, because the other guy may be dealing with oranges.

If you can talk about it, you can change it

One of the things I love about Profit First is that in encouraging us to pay ourselves first for our hard work, it essentially encourages us to believe that we deserve that money. It puts money at the forefront of the conversation of why we’re in business in the first place. Sure, you have a great service, product, or skill that you want to offer to the world, but let’s face it, you’re also here to make a profit.

Here’s my two cents on how to talk about money with the people closest to the backend of your business, with the goal of eliminating secrets, banishing anxiety, and making smart decisions that will help you to sustain and grow your business.

Talking about money with your bookkeeper

Your personal financial health and your business financial health are intertwined. Be honest with us about both. We can’t help you with your money if we don’t know what’s going on with your money. Are you in a jam with your finances at home? Are you not making a living wage? Maybe we can make a suggestion on the business end of things that will help to lead you out the hole you might be digging.

Bookkeepers are experts at reviewing your financial data, so we don’t give money advice without having facts to back it up. In other words, we got receipts. Even if your bookkeeper isn’t privy to your personal bank statements, it’ll likely all get fleshed out for her when she reviews your business statements and

And we all have our dirty little money secrets. The things we like to splurge on that no one else thinks worth a dime. Or the occasions we got ripped off and felt we should have known better. As bookkeepers, we’ve seen it all—maybe we’ve even been there ourselves—so nothing is too taboo to share. Tell us so we can help.

Talking about money with your team

What’s appropriate to share with your employees and contractors? This one may surprise you.

I’m a fan of having an open-book policy with your staff and sharing how things are going with your business. I share my P&L figures with my team on a regular basis—they know my allocation percentages. Employees are your boots on the ground. The more they know, the more likely they are to be invested in increasing revenue for your business. Their success is tied to your success, especially when you’re doling out bonuses based on your profits at the end of the year. Isn’t it great when your employees point out how you can eliminate an expense because they’re no longer needing the service you’ve been paying for?

Most business owners don’t want their team to know how much they’re making. But what I’ve seen is that most of the time, your team thinks you’re making more money than you actually are. Sharing your business finances with them can dispel the myth that you’re swimming in cash, and that it would be easy for them to leave and become your competitor—one of the biggest fears that business owners have.

I’ve started to gently encourage my team members to open up a bit about their personal finances, if I have their permission to do so. I can see that it affects their work when they’re struggling at home—we all have money anxiety at some point. If you have staff meetings, you’re probably already providing some kind of business education to them on a regular basis, so consider adding financial literacy webinars and other tools and learning to the mix.

Talking about money with your business partner

Profit First is beautiful for business partnerships because it puts percentages in place from the starting block that both (or all) partners agree to ahead of time. Sure, there will be issues from time to time, but they’re much easier to mitigate when you’re working from an established framework.

It’s also important to know your money personality. Is one of you a spender and the other a hoarder? For example, you could have differing views on what constitutes a necessary operating expense, but at least with Profit First in place, you share a basic understanding of how money will be handled in the business.

Talking about money with your life partner

It’s common for business owners to discuss major decisions about their business (such as big-ticket purchases) with their life partner, even if that partner doesn’t have a legal interest in the business. They’re vested in its success because they’re vested in you.

We advocate for some regular conversation about your business with your life partner. I know a couple that talks about it every Sunday morning, but if that’s too much taboo for you (!), I recommend doing it at least quarterly. Make them privy to the details of your Profit First strategy. I often see conflict where the partner doesn’t understand the difference between your revenue and your profits. You can show them your Profit First allocations to help them understand that you have a plan in place for when and how often money will be flowing out of the business and into your pockets—and how you’re avoiding the need to invest future household income into the business, because you’re saving in advance for things like taxes.

It gets easier

Take it from a bookkeeper—the more you talk about money, the easier it gets. Don’t let a lack of practice hold you back from making progress. Practice!

Customize Your Profit First System with Advanced Accounts

The Profit First system is simple enough that most people can see the immediate rewards of paying yourself first. But no two businesses are alike, and each will have its own complexity. We love that it’s so easy to customize the system to meet the needs of your unique business, by opening additional, “advanced” accounts.

Every business following Profit First sets up the five foundational bank accounts—the buckets, if you will—to distribute income. Then you make your fixed allocation percentages twice a month without deviation. But you’re the owner and you know your business best. After a while, you might notice that something in your system needs tweaking.

Maybe you didn’t foresee having to pay a large invoice that ended up draining your OPEX bucket. Now you’re aware that it’ll be an annual expense for your business—same time, next year—and you want to plan ahead. For example, CrossFit gyms have an annual affiliate fee of $3000, and sometimes owners forget about that until it’s right on top of them.

Take some pressure off yourself. If it will help you to create a new bucket, or account, to meet a specific expense, we encourage it. In fact, there’s a saying that gets kicked around amongst Profit First professionals…

When in doubt, create an account.

By the way, we’re calling these “advanced accounts,” because this is technically an advanced Profit First technique. (That’s right, young Jedi, you’re advancing.) But really, it’s quite simple. These are just extra accounts (or separate accounts, new accounts, sub accounts—whatever you want to call them) beyond the foundational five. Name your accounts in whatever way makes sense to you.

There are lots of reasons why you might want to open up an advanced account and flow some cash into it on a scheduled basis.

A payroll account is an advanced account that we think every business owner should have (unless you’re a solo operation). This ensures that you protect employee and contractor wages so you don’t accidentally run out of money to pay them.

Or, let’s say you know you’ll need to make a big purchase down the road, such as new exercise equipment for your gym. You could open an equipment account and start accumulating those funds now (rather than potentially facing the sudden expense when a machine breaks down).

Or maybe you want to invest in continuing education courses for your staff. If it’s important enough to be a goal, create an account for professional development and start saving for it.

Maybe you want to embark on a marketing push for your business, which will involve hiring multiple vendors. Having a separate marketing account might encourage you to determine a budget in advance and stay true to it, without comingling those expenses with all the other things in OPEX.

Creating more accounts ensures that money is there when you need it to be. It’s really all about preparation and peace of mind.

How to put money in advanced accounts

So you’ve determined you need to create some extra accounts. How are you going to make this work within your Profit First system? Where will the money come from?

Like the examples we’ve been talking about here, most of the advanced accounts that our clients set up are to isolate and cover specific business expenses. In the absence of a new account, you’d be paying these bills out of OPEX. So you’re almost always looking at reallocating money from OPEX when you create an advanced account.

Your allocation target is quite simply how much money you want to invest into the thing you’re creating the account for, and in how much time you want to achieve it. That affiliate fee is $3000 per year? Divide it by 12, and figure out the percentage of your income that equates to. (You want to accumulate $10,000 in an equipment account in 8 months time? Divide $10,000 by 8 and figure out the percentage of your income that equates to.)

You’ll then subtract that percentage from your current OPEX allocation percentage. Your OPEX funds aren’t really being reduced per se, they’re just being redistributed into new accounts so you can very clearly target money toward specific expenses.

Advanced accounts can come and go

You don’t have to use them all the time.

For example, when I’m thinking about growing our team, I start transferring money into my new hire account. I won’t actually bring them on board until I’ve got at least one month of their salary in there (and provided I was able to comfortably accumulate that pay within one month’s time. Check out our important guidance on this in How to Profit First Your Way to Team Growth.) Once I’ve actually hired them, I’ll transfer the funds to the payroll account, and let the new hire account remain dormant for a while—until I’m thinking about hiring again.Occasionally there are times when the creation of an extra account won’t be for an expense, or when it might make more sense to assign dollar amount allocations rather than percentages. Let us help you navigate these trickier cases.

How to Profit First Your Way to Team Growth

Bringing on new employees is an exciting part of business growth. But if you haven’t done it before, or even if you have, it may be daunting to think about taking on the added responsibility. Can you afford the expense of a new hire? How do you navigate the administrative aspect of paying them? Maybe you’re only paying yourself thus far, and that’s simple enough—you just transfer fixed percentage allocations into your Profit and Owners accounts twice a month. That all changes when you have a team.

As you know, the Profit First system involves setting up five separate bank accounts for the distribution of funds. But there are smart reasons to create additional accounts, or subaccounts, to earmark and protect funds that need to be reserved for a certain purpose. Paying employees might be one of those reasons. 

Split Payroll from OPEX?

That is why we often suggest that if you have any employees besides you as the owner, you should create a separate payroll account, as a subaccount of OPEX. 

Why do you need a separate payroll account? Why can’t you just take from OPEX to pay your employees? Two big reasons. 

A separate account makes sure the money you’ve allocated for employee wages can’t accidentally get intertwined with all your other expenses, and then accidentally spent. For example, if your rent and your payroll are both paid out of OPEX and one of these expenses would happen to place you in overdraft this month, the bank will decide what to pay. The bank might choose your rent over your payroll. They’re both important, but which is easier to rectify?

Having separate accounts ensures that your team members get paid no matter what. Bouncing a payroll check is really the absolute worst for employee morale. 

Having the payroll account split from OPEX also ensures that you meet your obligation to set aside the taxes you owe to the federal government on behalf of your employees as soon as you pay their wages. These funds can’t get accidentally spent either. This is another big one. You don’t want to get in trouble with the IRS for failure to pay your payroll taxes.

A payroll service can help you calculate your employee wages and payroll taxes. Check out a few services here. We recommend OnPay and you can check them out at our affiliate link here.

And don’t let us scare you too much. Read our blog post on some common payroll mistakes and how to avoid them.

Can You Afford to Hire Help?

Theoretically, a new hire should help to generate revenue in some way, or free up the owner to do so, but in reality things can take a while to get off the ground—or things might not go according to plan. You need to onboard the new employee, which takes time. Time where they may be costing you time and money. 

And according to Profit First principles, hiring an employee is a business expense that you must be able to meet without increasing your current total OPEX allocation. This means, for example, that if your current OPEX target allocation percentage is 50%, and your payroll subaccount target is determined to be 25%, then your OPEX becomes 25%.

So how do you determine what percentage to allocate toward the payroll subaccount?

If you’ve already got employees on the books, take a look at last year’s figures to see what you paid for employees in total. Determine what percent of your revenue that figure was, and use it as a basis for your payroll target allocation percentage.

If you’re considering your first hire, you will want to have one month’s worth of employee salary as a buffer in your payroll account before you bring them on board. Determine what that figure is, and then try to transfer 2-3% from OPEX into the payroll account each month until you’ve reached that figure. 

The length of this process will enlighten you as to whether hiring someone now is feasible. Did it take just a month or two to accumulate that one-month salary buffer? Then you can probably afford to add that employee. On the other hand, did you struggle to make available 2% from OPEX each month to transfer to the payroll account? If that’s the case, you need to rethink your decision.

Independent Contractors… on Payroll?

Your business might depend on independent contractors, rather than employees. In terms of cash flow management, we recommend that you compensate them from your payroll banking account if they are providing your clients substantially the same service that is provided by your business as a whole (for example, personal trainers who are contractors at a fitness studio). If, however, the independent contractor is providing a service FOR your business, such as janitorial or marketing services, you should include this expense as part of OPEX.Here’s more on leveraging team members in your wellness business.

Analyze Your Expenses and Increase Your Profits

Who doesn’t want a more profitable business? We’re in business to help people, sure, but we’re also here to make a living. And if we want to make a good living with a business, we need to be profitable.

Generally, there are two ways to increase your profit:

1. Increase revenue (while keeping expenses in check), or
2. Reducing expenses (while keeping revenue the same)

This article will focus on the latter—reducing expenses to increase your profitability. Because while increasing revenue is important, most businesses forget that increased revenue is not an excuse to lose sight of expenses. The beautiful thing about this strategy is that it simply involves cutting some expenses to increase what you keep. Expenses that you probably don’t need anyway.

To reduce your expenses, simply conduct an Expense Analysis. There are many ways to conduct one, but here’s a simple method that anyone can use:

Make a list of your common and recurring business expenses.

• Go through your bank and accounting records, and be on a special lookout for those small monthly subscription services that you no longer really use or don’t use fully.

Trash or Trim your list.

• Write TRASH (or strike through) any expense that you can eliminate without negatively affecting your business (think about services that you no longer really use, but are still paying for)

• Write TRIM next to expenses that can be negotiated down to a lower rate, replaced with a competitor at similar quality but lower price, or downgraded without issue to the business. 

Contact the vendors to cut/trim expenses.

• Do your research ahead of time if you plan to ask for a reduced rate.

• If you’re switching software, set up a free trial of the new service first before cutting out the old one. If needed, hire a professional to help with the transition.

Any business can do this in a couple of hours. The more your cut, the more profitable your business becomes–as long as you’re not cutting out vital services in an effort to save a few dollars. It’s worth weighing whether cutting out a service will mean less fluidity of workflows or more time investment for you. 

We recommend going through this process on a quarterly basis at a minimum. This practice will keep you financial efficient and profitable.

Not sure if you can eliminate a particular expense? Try this test…

Eliminate the expense for a month, but be prepared to regain if needed. How do your customers react? Does your team notice its absence? Are you having to spend any additional time connecting dots that are no longer connected? If no one is negatively affected, then you could probably eliminate the expense.

Remember the old saying, “It’s not what you make, it’s what you keep.” Doing a quarterly expense analysis will help you keep more of your money, and help you earn higher profits. If you need help implementing Profit First in your business, let’s connect. Schedule a call with us today.

When and How to Reassess Your Profit First Distributions

So you’ve implemented Profit First in your business and are on your way to establishing smarter expense spending habits, financial security, and peace of mind. You’ve determined the target allocation percentages for your five bank accounts—and you’re maintaining the discipline to distribute your revenue into those accounts consistently according to those percentages. What’s next? Should you sit back and relax?

Not exactly! The Profit First method is designed to help you not only become immediately profitable, but to set you up for continued success in the long term. The goal is to have distributions that are not only achievable and adequately meeting the needs of your business and personal priorities today, but that are also optimal for business growth, efficiency, and sustained profitability going forward. Making sure that you’re dividing your revenue into the optimal percentages, in turn, enables your business to be fully optimized and, ideally, one step closer to an optimized quality of life.

You see, your target allocations can and should evolve over time depending on your revenue and your needs. The Profit First assessment graph serves as the fundamental guidance for how to allocate funds based on revenue range, and it’s largely appropriate for most businesses, but your specific business and your priorities will dictate if, when, and how your percentages will fluctuate.

When to Reassess

You should review your target percentages every quarter. Quarterly reassessment allows you a few months to see if your current allocation percentages are working fully in your favor, and if not, where you can make improvements.

(Actually, a quarterly review makes sense in every area of your business, but it’s particularly important for your finances, and we have some ideas here on where to start.)

How to Reassess

There are a couple of ways you can do this.

You could start the assessment process from scratch and determine target percentages based on your revenue range using the Profit First assessment graph. But what if you haven’t yet made the leap into the next revenue range? It may look as if no changes are necessary to your strategy, but you probably know better. You’ve come so far already, and you likely have a clearer picture of your desired and attainable goals.

When your revenue changes, it’s definitely a good time to reevaluate your target percentages, but you might need a professional to help you make sense of the numbers and set new quarterly goals. We can help with this.

Look at OPEX

For starters, you can look at your OPEX account for guidance. Are you accumulating more money in your OPEX account than you’re actually needing to spend? If so, you know you can safely reduce the distribution.

Let’s say you’ve got a $5000 surplus sitting in OPEX that’s built up over the last quarter. You can figure out what percentage led to the accumulation of that surplus, and you can safely reduce the OPEX distribution, in increments of 2% to 3% per month.

This would be the time to consider how you could better make use of those funds by reallocating them to another account or by creating a special account for another use that also falls under OPEX, like a payroll account.

Let’s say your OPEX is at the target allocation of 50% and you want to take some continuing education classes which will improve the services you provide in your business. You know you’ve got some wiggle room in OPEX (that $5000 cash surplus as proof) so you decide to create a separate account for, say, Personal Development and mark its target allocation percentage at 5%. You then reduce your OPEX target to 45%. Soon enough you’ll have the funds for that class, while still being able to cover your other business expenses.

Or you could create a separate account for large annual expenses or emergency maintenance. It really all depends on what you need.

Owner’s Pay

Having too much revenue to distribute is a nice problem to have, but what if your revenue is down? Should you cut your own pay to compensate? We don’t ever recommend reducing your Owner’s Pay percentage when revenue is down, though it may seem like an easy solution. Check out this blog post for guidance on determining your Owner’s Pay percentage according to Profit First principles (hint: you’d only ever reduce it when revenue is UP).

When to Talk to Your Accountant

Any time you have a big change in revenue—certainly if your business moves into another revenue range on the Profit First assessment chart—it’s wise to talk to your tax professional. That’s because beyond any changes you make to your cash management system, there may be changes to your tax liabilities. A good accountant will recommend ways to reduce your tax burden, such as investments or deductions, that are specific to your overall finances and priorities.

And come September (aka the financial third quarter), you should ask your accountant to estimate your tax rate for the current year. You’ll have eight months worth of real revenue data, so there’s no need to make a guess based on last year’s figures. However, if you’re following Profit First principles, you should have enough funds in your Tax Account based on the performance of your business to pay your taxes. But your accountant can and should work with you to reduce that tax liability as much as possible. (If not, get a new accountant!)

You Have a Personal Savings; Why Not a Business Savings?

Many of us have a rainy day fund for when (not IF) things go south. Your car needs a new transmission, your roof has a leak, a child gets ill. These things happen, and our personal emergency fund is there waiting to save us, or at least minimize the impact.

But very few business owners seem to have an emergency fund for their business. And knowing your personal emergency fund is there to bail you out if needed is not what it means to have an emergency fund for your business. Business and personal funds should always remain separate.

There’s a lot of unexpected expenses that could come up in a business, from losing a big account to needing a new HVAC system to a water leak that needs to be fixed ASAP, attorney fees to help with a disgruntled employee or former client. We hope that none of these happen, but the reality is that they can and they will at some point.

The beautiful thing about the Profit First cash flow management system is that your business will start building an emergency fund for itself if you run the system correctly.

Here’s how Profit First helps your business establish its own emergency fund:

Twice a month, you’ll transfer a percentage of revenue to your Profit bank account. (How much depends on your own profit allocation percentages.) Over time, your Profit account grows.

Then, each quarter, you’ll transfer half of the funds in the Profit account to your own personal account to do with as you wish. It’s your reward as the business owner. Use it to pay down personal debt, buy something fun, take a trip, you name it.

The other half will stay in the Profit account as an emergency fund, and you can let that fund grow. Now, when (not IF) things go south, the business has its own support.

Ideally, you’ll want to reserve three to six months for business expenses in your Profit account or another emergency account. It’s generally not a good idea to have too much cash due to liability, so once you have a fully-funded emergency fund you can use 100% of the funds in the PROFIT account.

And no matter what the size of your current emergency fund, know that every dollar will help you rest a little bit easier.

Need help getting your accounts set up or determining your distribution amount? Let’s talk!