Tommy-Lee Zmuda, installer and founder of The Boiler Business, explains how employing a profit-first model could result in a tune-up for your business.
Are you the type that wonders where all the cash is gone? Long hard hours just to cover the basics? Frequently late on payments to the merchants, barely paying yourself a proper wage with no predictable profit?
What would happen if you began taking your profit first? You know, the money comes in, and you swipe your profit before all the other overheads eat into it? It might sound like some shady idea to avoid paying your taxes or Del Boy’s advice to the kids of Peckham. But what if you knew that many people are starting to adopt this way of thinking, turning their business around by adopting the principles set out in that notorious business classic, Profit First by Mike Michalowicz.
The profit-first formula
The GAAP (Generally Accepted Accounting Principles) formula for calculating your business profit is Sales – Expenses = Profit. Nice and simple, isn’t it? However, most small business owners will often find that after VAT, overheads, supplies, and some more tax, that the profit leftover is not what they hoped for. However, there is a simple way we can get away from this monthly disappointment and ensure your business stays predictably profitable.
So, what is this magic profit first formula? Well, it’s the same ingredients to the generally accepted formula (Sales – Expenses = Profit) except we take the profit first: Sales – Profit = Expenses.
I know this looks simple when written on a blank page. If you are in the same position, like when I first read this book, you are probably worried you would not be able to pay all your overheads on time, and this is the point! Many of us are not in control of the expenditure, have no idea on what we are spending and have no cash reserves to absorb seasonal fluctuations in revenue!
Back in 1957, some clever chap called Cyril Parkinson wrote his bestseller, Parkinson’s Law. In his most famous line, he states that “work expands to fill the time available for its completion”.
He then goes on to explain that it is human nature to use the resources that are available to us. If we are given five days to complete a project, it mostly takes five days to complete. Yet, given seven days to achieve the same project, it would most likely take seven days to complete.
So, what has that got to do with profit and the Profit First book? The book explains Parkinson’s Law in more detail but then applies the same Parkinson’s theory to our money. By taking the profit first, we are forced to find ways to spend less money.
Most trade businesses don’t take the time out to understand their own accounts. Logging in and seeing that healthy balance, they will often make purchase decisions based on a poor understanding of what profit they actually have. As Parkinson’s Law warns us, they consume the resources available to them.
The merchant-first version
Since sharing this book with people a few years ago, we have listened to several people in our industry get stuck with percentages and paying for supplies. This is why we prefer to recommend to the domestic business to consumer market the slightly tweaked Profit First – the Merchant First model. If you work in the commercial business to business market, please study the original model.
Here is a quick summary of the Merchant First model. It starts with taking your 50% deposit from the customer and paying the merchant for the installation goods first. I understand that the merchant invoice is rarely, precisely 50% of the customer’s invoice, but that’s not the point. We advise this to improve cash flow and make the maths easier. Once the job is complete, and the final balance paid, it’s easier to allocate the remaining money to different bank accounts.
The merchant is already squared up from the deposit payment. Now transfer your allocation (1%/5%/10%/25%) of the remaining money to your profit account. Next, transfer your VAT to your separate tax account. If you are VAT-registered, try to put the full 16.6% of gross turnover away for the VAT man. This will be more than needed for VAT and will produce extra funds for you to save towards your Corporation Tax. Remember, if we are going to be profitable, we are going to pay taxes!
Now you should feel good that the most important things are paid for. The goods, the tax, and the business profit, should all be boxed off. As the business owner, the task is now to look at your expenditure and labour costs and cut, slash, replace, or simply improve the efficiency of every pound that is going out. Your recent bank statements are the first place to look for savings.
Why pay the merchant first
There are three solid reasons to pay for the goods as you go rather than forever trading on credit. Firstly, let us suppose you are at a point of taking an adequate level of stock from the merchant but ask for better cash terms with no credit. In that case, you will have taken the risk away from the merchant but still be contributing towards the merchant’s sales targets and will get better terms for doing so.
The second reason is a better day-to-day understanding of what is actually available to spend. What’s left after taking the deposit and paying the merchants is tax, profits, and overheads. There will be fewer surprises at the end of the month by doing this.
This leads into the third leading reason, avoiding merchant debt. Often this is the unwanted trap of being put on ‘stop’, paying your statement late just so that you can get more stock and keep going. Never being able to pay your balance in full means you are in merchant debt and those favourable terms are not going to be offered to a business that is frequently going on ‘stop’ and paying late.
Rather than using the merchant credit account like a bank overdraft, get a bank overdraft! Think of it a buffer zone to be avoided. An overdraft is only there for emergencies or to tie you over while a payment comes through. Although merchant credit is interest-free, it will be due in 30-60 days, while an overdraft would allow you much more time if required.
The profit-first day
The Profit First book advises making your profit and tax transfers twice a month. Getting started with a half-day per month is probably more than your competition will be doing. Let the competition be busy with busy-ness, while you work on the business. Think of it as fine-tuning, making a leaner more efficient profit machine.
Stepping up a gear, take a full profit first day once a month or quarter for number crunching and tweaking costs. The clues to your healthy profit margins are all in the numbers, and you will only make progress by regularly looking at the numbers.
Other than culling overheads, changing suppliers, and your usual monthly accounting tasks, you could use the same day to track the effectiveness of your marketing channels. This will allow you to find any weak links in your marketing and remove the costs if necessary
The Boiler Business Community, headed up by the Built to Last team, is a highly engaged and supportive community built to help the plumbing and heating industry get their heads around what it means to build a business that works for the owner, the team, and the family and friends the business should support. Find out more over on the group: www.facebook.com/groups/TheBoilerBusiness.
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