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.
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!)