top of page
  • Writer's pictureJoe Minich, CPA

A CPA's Thoughts on Profit First

Updated: Jan 12, 2022

I have worked with many small businesses over the years that have implemented or asked about financial strategies from the popular business book Profit First by Michael Michalowicz.

Without going into an entire cliff notes of the book, it's basic premise is pretty simple. Mr. Michalowicz asserts that most business owners view profit as an end result. You have your revenue, you take your expenses, you are left holding your bag of profit. That's not wrong, that's how a P&L statement reads. He also argues that owners become convinced that through this way of thinking, the only way to grow the profit is to chase revenue growth (which sometimes is true, he admits).

His proposed alternative is to reframe the owner's mindset. Essentially to rework the basic P&L equation into revenue less profits, and the remainder is your budget for expenses. Take your profit first. Set it aside. Don't touch it. He advocates setting up multiple bank accounts to silo your money, with profit being one of them. Through doing this, instead of chasing growth endlessly, your business right-sizes itself in some sort of natural equilibrium. But at the end of the day, it's the same equation, just reworked, right? It's just a shifting of priorities and mindset. And all we are doing is essentially a prescribed methodology for budgeting. And we all know budgets can never be broken and nothing even goes over budget, right?

His approach bakes profit into every aspect of the business. Every transaction, every product, every service, every cost, taxes, owner pay, they all come after profit. Some of you may be asking, are we running in circles here? Doesn't a well managed business do this anyway? Isn't every business budgeting?

Well, yes, but not all businesses are well managed. Believe it or not Bob Smith, Contractor works on site 60 hours a week juggling customer, employees, suppliers, equipment, and whatever fires pop up each day. Mr. Smith does not sit down very often and do a detailed analysis of his profit margins and 12 month cash flow projections or calculate the ROI on that skid steer he makes a big payment on every month.

Mr. Smith bills his customers, collects payment, and checks his bank account to make sure he has enough cash to pay the bills. He makes most pricing and planning decisions with his intellect and experience, or as some would admit, gut feelings. At the end of the year his accountant tells him what his profit was, and that's that. Mr. Smith is the perfect audience for Profit First. It introduces the basic concepts of business financial planning and analysis in a way that is easy to digest.

The Dave Ramsey Connection?

I have no idea if Mr. Michalwicz modeled his Profit First model after Dave Ramsey, but it sure seems possible. For those unfamiliar with Dave Ramsey, he is an extremely influencial personal finance guru. He's a higly revered man, and, at risk of angering his loyal followers, I do like his overall message and think his net positive effect on society is very positive.

It's just.... very basic stuff he puts out -- cash good, debt bad, invest in the stock market, live frugally. Generally good advice, right?

But, a lot of what he advocates also flies in the face of conventional finance concepts and defies basic math. Debt is not always bad for instance, it depends on the interest rate and what one would alternatively do with the cash flow. And to be fair to Dave, he does occassionally admit this. Dave's teachings often fly in the face of such basic financial concepts of opportunity cost and time value of money that us CPA's and other finance professionals hold so dear.

But what Mr. Ramsey understands is human psychology. That we don't always make good choices. That if we have $100 that should be going into our IRA or paying down debt, it won't always get there.

Michalwicz's Profit First is much the same. He understands we are not emotionless computers doing math equations to make money decisions, but complex beings with emotions, fears, whims, and all sorts of external pressures. Both author's philosophies are not necessarily "this is how you can achieve absolute optimization of your finances" as they are "this is how to not shoot yourself in the foot and have pretty good finances". And that's fine, a lot of people need help to keep from shooting themselves in the foot.

Good Being the Enemy of Great

That lands at my greatest critique, that the book "talks down" to the kind of businesses I typically seek to work with in my advisory practice. It coaches up to a level of "good enough" which is fine if that's your goal. There's something to be said for comfortable. A commonly cited statistic is that 2 out of 3 small business fail by year 10. Profit First could no doubt save some number of those just by getting them to focus on the basics. But to have a mindset to strive for the exceptional, you need to tweak some of the psychology prescribed by the book.

The most significant area the book falls short is the mindset towards growth. Cash fuels growth. By setting aside all this cash in a formulaic manner, for what? If you want to grow, you are probably going to need to leave some of this cash in the business and use it to fuel growth. There's a good chance you can even leverage some debt to multiply your growth factor. And that is where more advanced financial planning and analysis should come more into play.

Can you afford the new equipment you need to offer a new service? Can you hire and train a new employee to bring new capacity online? These kinds of answers lie beneath the surface of how much cash you have siloed in certain bank accounts. And, gasp, you may need to sacrifice a couple percentage points in profit this year. But if you are making the right decisions, that sacrifice of some profit this year will return much more profit in the coming years.

The Conclusion

A lot of business owners ask me what I think of the book and if they should implement or continue its prescribed methods. To them, I say, it depends. For one, I tell them if you are hiring me as an advisor I hope we can quickly earn your trust to progress beyond this Business Finance 101 level. We can get you there without having a half dozen accounts to silo your money, and it's not because I don't want to reconcile that many accounts each month. It's that projections, ratios, cash flow analysis; these basic financial planning and analysis concepts have it convered. We'll get to the same place, we'll get beyond that place.

I do think it has a lot of value to people that don't quite have an advanced understanding of business financial concepts and don't have expertise, advisors, or mentors to lean on. It does, much like Dave Ramsey for personal finance, establish a strong connection between business finance and behavioral pyschology. Frankly, if you are undisciplined with money and prone to rash decisions, this can help. There is a lot to takeaways in that regard even if you don't dive deep into his more prescriptive methods.

At the end of the day, anything a business owner, or individual can do to move beyond running their finances on gut feelings and whimsy is a step in the right direction. And the most important takeway ultimately is discipline. If you set aside cash, if you develop an expense budget, these exercises mean nothing if you don't track them and stick to them.

38 views0 comments


bottom of page