hey it's patti scharf CPA and co-founder of catching clouds the leader in
e-commerce accounting today I'm gonna talk about profit first by Mike Michalowicz
I actually looked up how to say his name
because I kept butchering it and all the other videos anyway so I want you to
stick around to the end because I'm going to show you how we apply this
using Xero in our own firm but I need to tell you a little bit about the book is
this isn't going to be a review or summary necessarily of the book but I do
want to give you enough information so that you see where I'm going when I show
you how I do this in Xero alright so let's get started so I read profit first
several years ago I know quite a few accountants who are either friends with
Mike or they are certified profit profit first professionals or both and I just
kind of wanted to see what it was all about and what was going on and as I was
reading it I noticed there was a lot of personal finance concepts in the book
and it and I think it's great I think he did a great job of pulling together all
these different concepts and bringing them together for a business owner to
understand how cash flow works and how to set themselves up for success
financially with their business the first one is pay yourself first so maybe
you've heard this like when you got your first job or something like that and
they had a 401k and they said hey you need to put aside you know 10% or as
much as you can to have it come out of your paycheck you won't even see it you
won't spend what you don't see that concept is really critical in profit
first the other concept that I noticed just kind of jumped out at me is the
envelope system so let's say you were making $2,000 on your paycheck and you
had to pay for rent and groceries and clothing and fun money and stuff like
that what they would say is hey until you're familiar with how to manage your
finances use it all with cash so you you go to the bank you get $2,000 out and
you get a bunch of envelopes and you put $100 here and $500 there and $200 there
for all of these different purposes and then when you need to buy something
you only use the money that's allocated for each of those individual things
again great concept especially if you're just learning how to manage your
finances so all of this is pulled together really nicely for a business
owner to help you understand how to manage cash flow how to make sure that
your business is profitable from day one he also talks about concepts like debt
and setting up an emergency fund and different stuff like that I'm not going
to go into all that I highly recommend you read the book I think it's great for
everybody whether you're a seasoned professional or not I think it's got
great concepts in there and he does a great job of pulling everything together
there was one thing that he suggested that I thought was logistically
burdensome and somewhat unnecessary and that was the idea of setting up
different banks so what are you saying was create a separate bank account at a
different bank from where you normally Bank and set up a bank account to
collect profit set up another bank account to collect money for income
taxes and don't touch those unless you are specifically like its distribution
Day for getting some of your profit out or it's tax day and you need to pay your
tax bill otherwise it needs to be at a different bank so that you're not like
borrowing it you know for other purposes for operating expenses and things like
that and he's saying that if it's at your own bank then it's gonna be too
easy to borrow money from there so I guess my first reaction was a little bit
judgmental where I'm like hey you you're in charge of a whole company just pull
up your britches and do the right thing if it's for taxes don't spend your tax
money but I realized that sometimes that's easier said that done and so I
understand where he's going with that and and I think that he's on the right
path but me as an accountant like I just didn't want to go through all the hassle
of setting up a separate bank account and pain associated fees and all that
other crap so so what I did is I came up with my own method and I want to show
you how I use it so this is how I do it in Xero you can do it in QuickBooks
Online you can do it however you want but this is how I do it
all right so I've got a couple of different accounts here I've got one for
the checking account one for the payroll account and one savings for operating
expenses okay checking account is just where all the money flows in and out and
whatever payroll is only for payroll I will keep one month's worth of payroll
in there at the most usually I only keep the next upcoming payroll amount in
there and then everything else is going to be sitting in the operating expense
savings account so it's collecting savings interest in things like that so
let's say you get a payment from your customer for ten thousand nine hundred
twenty-five dollars it gets deposited into your account you code it to sales
actually in this case ten thousand is sales and nine hundred twenty-five
dollars is sales tax that you've collected now we don't want to spend
that sales tax just spend it we want to make sure that it's there when it's time
to pay in your sales tax liabilities so the first thing I did is I transferred
all of this deposit over to the operating expense savings account okay
so if you go look at the savings account you will see a deposit over here of ten
thousand nine hundred twenty five dollars you can do this online
super easy okay so here's what I'm doing the first thing I want to do is
segregate that 925 and set that aside for sales tax liability with the other
ten thousand dollars that came in I want to split that up into the different
allocation percentages that I've identified for my business so in this
case in this example it's going to be 15% for profit it's going to be 25% for
owners compensation it's going to be 15% for income taxes and the remaining 45%
is going to be for operating expenses so when I go to profit first allocation
here's the 925 that I've set aside okay and I've set that up in a current asset
account called savings sales taxes so this is going to show up on my balance
sheet right and then with these three other ones profit savings owners
compensation and income taxes I set aside fifteen percent
profit 25% for owners compensation and 15% for income tax all the rest of it is
going to be sitting in operating expenses okay so now I've got 4,500
dollars sitting in operating expenses which non coincidentally is 45 percent
of that 10,000 okay and then I can just transfer this back to the payroll
account when I need to use it I can send it to the checking account when I need
to use it and everything is good now why do I do this why do I go through the
hassle of doing this if you look at the dashboard you will see here's the 3000 I
transferred to payroll the checking account the checking account is
basically where it was to begin with and savings account you'll see only has
fifteen hundred dollars in it but if you go to the balance sheet you'll see the
actual balance in the savings account is seven thousand nine hundred twenty-five
dollars and you may be going to wait what here's what I did if you drill down
into that savings account I have balances for each of those
different ones okay let me show you how I got there okay so
if you go to the chart of accounts you'll see that I set up these different
current asset accounts I set up one for profit and one for owners compensation
income taxes sales taxes emergency funds okay then I went to balance sheet and I
edited the layout so edit this layout and then I selected all of these
accounts and I grouped them into an account called savings account so I
created an account that's called savings account and when I set it up I checked
this box that said show summary only that way you won't see all the details
of all of these accounts you'll just see that one savings account number okay
so when you're looking at your dashboard you only see the amount that's left in
the operating expenses savings account because everything has been transferred
to a current asset account so they're actually not in here if you look
in here it's all been moved out as a spend money transaction or been
transferred to another bank account or something like that so there really is
only $1,500 in this savings account according to your accounting but then
when you look on your balance sheet you will see you will see the true balance
that's in your savings account so this should actually match what you see on
your bank statement with the bank because all that money is still in the
bank it's just you've earmarked it for a different purpose so it doesn't show up
on your dashboard so hopefully when you're looking at how much money you
have to spend when you're looking at your dashboard and zero you know oh I
only really have $1,500 left for my operating expenses so there are
advantages and disadvantages to this method as you might imagine advantages
are you don't have to deal with all those different multiple bank accounts
another advantage is when you look at the dashboard you're you're not seeing
all that other savings so it's it does achieve that out of sight out of mind
kind of a thing but the disadvantages are it's really easy to get to like if
you're if you're managing your books by looking at your bank account which I
would never recommend it's going to look like money is there and available for
you so you really need to trust your accounting and then the other downside
is you have to kind of stay on top of it there's some ways of combating that and
actually Mike McCalla wits talks about that in his book as far as how to handle
your bill payment situation and things like that to keep it kind of manageable
and under control but this method works a lot better from for me one of the ways
that I manage it that requires a little less headache and administration which
maybe you might want to wait until you're a little bit further along in
your journey is I'll just see how much money is a good balance to keep in my
checking accounts so that I I know I'm not going to overdraft stuff let's say
three thousand dollars or five thousand dollars or one thousand I don't know it
might be different for your business and then I keep just one paychecks worth of
money in the payroll account everything else gets transferred to
savings account and then I allocate it out based on percentages and things and
that's all there is to it I hope you found this video helpful if you did
please like comment and share if you haven't already please subscribe and
I'll catch you later