In the last article, we discussed options to generate more income streams and briefly alluded to the Profit First concept.
Navigating personal finances often resembles a complex puzzle, with bills, expenditures and financial responsibilities competing for attention. But in the pursuit of financial stability and growth, the Profit First method emerges as a dynamic solution that challenges conventional money management norms. Made popular by Mike Michalowicz, the idea introduces an innovative concept that could redefine your financial journey. It was a concept generated to apply to businesses.
At its core, it advocates for a simple, yet impactful transformation in how you manage your money. Instead of relegating profit to what’s left after expenses, Profit First encourages prioritizing profit right from the start. By reshaping the traditional “Sales – Expenses = Profit” equation, the new approach follows a change to the formula: “Sales – Profit = Expenses.” This simple change in perspective can significantly alter how you view and handle your finances.
Winning now in dynasty fantasy football is similar to the Profit First concept. The goal in dynasty fantasy football is to win your league’s championship pool. Often, dynasty players will punt winning now to secure future draft picks, but those who are prioritizing winning now are likely to realize their profits earlier. In turn, they can use those winnings to join more leagues.
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Profit First System
The central premise of Profit First is to create a system that guarantees profitability by deliberate design, not random chance. By treating your personal finances like a business, you allocate a fixed percentage of your income to profit, ensuring that your financial well-being becomes paramount. This methodology prompts you to critically assess your spending habits, leading to more astute financial decisions.
To translate this to your personal finances, sales are equivalent to income and expenses are your bills and spending. Profit becomes the combination of savings and investments.
What sets this system apart is its simplicity. You don’t need to be a financial expert to apply its principles effectively. The core system is to create different bank accounts for the various parts of the equation. You should have all your income going to one account. Each month, on two set days, say the 10 and 25, you distribute a predetermined percentage to your Expense account and your Profit account. This strategy provides a simple representation of the financial health of different aspects of your life, facilitating informed choices.
Let’s say you allocate 50% of your income to expenses. By having all bills and spending go from one separate account and moving your money between accounts following this strategy, you can clearly track and see your spending.
Psychological Impact
Profit First’s impact extends beyond the numbers. Watching your profit account grow fosters a sense of achievement and empowerment. This positive reinforcement spurs you to gain control over expenses and fortify your financial safety net. Strictly following the predetermined percentage also ensures that you control your expenses initially. But as your income grows, both your profit (savings/investment) and expense (bills/spending) accounts will grow. You can continue to grow your income to buy more stuff but in a controlled manner.
Incorporating the system embodies more than just financial rearrangement; it cultivates a mindset prioritizing your financial triumph. It instills discipline, adaptability and a deeper understanding of your financial landscape. By focusing on profit, you naturally become more resourceful in curbing unnecessary expenditures, creating additional income streams and maximizing your financial potential.
Profit First Percentages
You can read the book by Mike Michalowicz to see the percentages that are given for businesses following a Profit First model. However, the following percentages are a good starting point since we are applying the strategy to personal finance.
You can get started by setting up the accounts and assigning the following percentages to each:
- Income Account: 100% of all income
- Expense Account (bills and spending): 50% distribution from Income account
- Profit Account (savings, brokerage or retirement accounts): 10% distribution from Income account
- Splurge Account (vacations and big purchases): 10% distribution from Income account
- Emergency Fund: 20% distribution from Income account
These percentages are not meant to be set in stone. For example, once the emergency fund account has 50% of your yearly income in it, you can lower that to 5%, then split the remaining 15% into your Profit and Splurge accounts (or into your dynasty fantasy football leagues). However you want to set it up within this framework, the main goal of Profit First is to create a structured, simple system to grow your future profit.
Thanks for reading my breakdown of the Profit First strategy and how to apply it to your personal finances! Find me on Twitter @ThePruPatel for more financial and fantasy football advice!