09 Oct Should your profit come first?
Many small businesses that I’ve worked with over the last three decades had cash flow problems. They’re behind on their bills and late on their taxes. And on their end of year profit reports, they are usually asking me “But, where’s the money?!”
I recently picked up the book “Profit First”, written by Mike Michalowicz, and highly recommend it for any entrepreneur. He writes that of roughly 28 million small businesses in the US, defined as having fewer than 20 employees, that 22 million of them are just breaking even.
Simply translated, that means that only 29% of small businesses are profitable. Petrifying!
He believes that the cause of this isn’t a lack of cash flow, but a lack of cash management.
The Formula: Income-Expenses = Profit
It seems like a logical formula, but it has a perfect trap for failure laid into it.
What often happens is the company has a good month/quarter, there’s money in the account, and all of a sudden it’s time to purchase that new piece of equipment, software, etc. – you can easily fill in the blank.
The truth is we start a business because we are excited about a product or service. And most small business owners I know are incredibly proud of the quality of that product or service. They usually deliver more than what the customer expects and are deservedly proud of that.
But they also want to make some profit.
Luckily, there’s usually a simple reason for no profit. When there is money in the account it gets spent on upgrades to the product, service or facility. Usually profit goes to everything except giving the employees bonuses and paying the owner.
C. Northcote Parkinson developed a theory in 1955 that demand expands to meet the supply. For example: work expands to fit the time allotted to complete the task, bureaucracies expand to spend all the budget, etc.
How this relates to a business is very simple:
If there’s money in the checkbook somebody is going to spend it.
So, what’s the solution? It is simple and you might not want to hear it.
A business owner must change the way they manage cash in order to have a profitable business. To that end, here’s a new formula for successful cash flow management.
Income-Profit = Expenses
This new pattern is very simple. The money comes into the checkbook and a percentage of profit is put into another account immediately! This includes money to pay taxes and owner’s pay. Now the company is run on what is left. The profit account is not raided, except to cover the expenses it is designated for.
This forces the organization to run efficiently, and get more creative, as to how to lower expenses while still providing the customer a quality service or product.
Let’s take this out of the realm of business and apply it to life. My first trip on my own was Spring Break at Daytona Beach with some good friends. We were young, and had limited funds, so we got creative. We economized but still had a blast!
This change of thinking will permeate the entire business and force everyone to be more creative in producing the product and service. It will also leave the owner feeling much less stressed, much more profitable and among the top 29% of small businesses in the U.S. in profit.
In closing, buy the book and read it! You deserve to be rewarded for the hard work and risk that you experience in your business every day.
Greg is an internationally recognized entrepreneur, lecturer and mentor that specializes in helping small business owners reach the maximum potential for their business. He’s lectured to and worked with business owners in ten countries across three continents and built several successful small businesses himself. Contact Greg: [email protected]