Profit First Bank Accounts

Sunday, April 2nd, 2023 in: Advice

Profit First Bank Accounts

What is Profit First?

If you’re a small business owner, the concept of ‘Profit First’ may seem like an illusion or wishful thinking. Conventional business accounting focuses on the formula: Sales – Expenses = Profit. However, a groundbreaking approach called ‘Profit First’ turns this traditional equation on its head. It suggests a new formula: Sales – Profit = Expenses. Here’s what you need to know about this transformative concept.

Profit First is a revolutionary business cash management system that ensures profitability from the get-go. It was created by Mike Michalowicz, an entrepreneur and author who recognized the prevalent ‘check to check’ cycle in most businesses, where entrepreneurs wait for the next sale to cover their expenses, leaving profit as an afterthought.

The Profit First system argues that instead of waiting to see what’s left after all expenses are paid, businesses should take their profit out first, and then operate with what remains. This way, profit is not something that might happen down the line; it is an immediate result of every sale.

To implement Profit First, you start by allocating a predetermined percentage of your sales revenue to profit. This amount is immediately transferred to a separate bank account. What’s left is used to cover business expenses.

The philosophy behind Profit First is that by taking profit first, you are forced to make due with what remains, which in turn makes you more innovative and frugal with your expenses. The system is based on the principle of Parkinson’s Law, which suggests that work expands to fill the time available for its completion. By applying this law to business finance, Michalowicz posits that expenditure swells to consume any resource or space given to it. Hence, by reducing the ‘available’ money for expenses, businesses become more efficient.

An essential aspect of the Profit First model is that it encourages entrepreneurs to examine their spending habits critically. By setting up separate bank accounts for profit, owners’ pay, taxes, and operating expenses, you gain a clear understanding of where your money goes and how much is truly profit. This approach not only helps in creating a buffer for the company but also allows for a more predictable and stress-free operation.

However, Profit First is not a magic bullet. It requires discipline, planning, and sometimes tough decisions about cutting costs. It also doesn’t absolve businesses from the need to increase sales and revenue. Rather, it encourages businesses to do so in a way that guarantees profitability.

In conclusion, Profit First is a compelling approach to financial management that prioritises profitability. It breaks the cycle of living sale to sale and instead pushes business owners to make profit an integral part of every business transaction. By flipping the traditional equation and prioritising profit, you can transform your business finances and ensure long-term sustainability.

Profit First provides a different perspective on how business finances should be handled, instilling a mindset of profit discipline. This could be the key to your business’s financial health and success.

Remember, it’s not just about making a profit; it’s about making profit a habit. When you put profit first, you create a system where your business not only survives but thrives.

Here are the main Profit First bank accounts required:

1. Income Account

The Income Account is where all revenue generated by the business is deposited. This account is used to collect all income and ensure that all incoming cash is accounted for.

2. Profit Account

The Profit Account is used to accumulate profit. The idea behind this account is to prioritize profit by setting aside a percentage of income as profit. This account is a way to ensure that profit is a priority and that the business is not just paying bills.

3. Owner’s Compensation Account

The Owner’s Compensation Account is where the business owner’s salary is paid from. This account ensures that the business owner is paid consistently and that they are not relying on profit to cover their personal expenses.

4. Tax Account

The Tax Account is used to set aside money for taxes. This account ensures that there is enough money set aside to pay taxes when they are due. It’s important to set aside money for taxes to avoid any surprises come tax time.

5. Operating Expenses Account

The Operating Expenses Account is where all expenses related to running the business are paid from. This account is used to ensure that all expenses are covered and that the business is not overextending itself.

VAT / Sales Tax Account

Additionally, if your business is registered for Value Added Tax (VAT) or sales tax, it’s recommended to have a separate account for these taxes as well. This account is used to set aside money for VAT or sales tax payments.

Do I need a bank account for Cost of Goods Sold (COGS)?

While the five Profit First bank accounts (Income, Profit, Owner’s Compensation, Operating Expenses, and Tax) are the main foundational accounts needed to implement the Profit First system, some businesses may benefit from having a separate account for the Cost of Goods Sold (COGS) or Cost of Sales (COS).

COS is the direct cost associated with producing and delivering a product or service. This includes materials, labour, and any other costs that are directly associated with producing the product or service.

While some businesses may include COS in their Operating Expenses Account, having a separate account can provide more clarity on the true costs associated with producing a product or service. This can help business owners to more accurately track their profitability and make more informed decisions about pricing and cost management.

That being said, not all businesses may require a separate bank account for COS. It ultimately depends on the nature of the business and the level of detail required for financial reporting.

If you’re unsure whether your business requires a separate bank account for COS, it’s a good idea to consult with a financial professional who can provide more guidance based on your specific circumstances.

Choosing a Bank for Profit First

When it comes to implementing Profit First in the UK, there are a number of bank options available. Starling Bank is a great choice for opening up accounts for Profit First, as it offers “Spaces” instead of opening several different bank accounts. Other options include Monzo, Mettle, and Tide. Traditional banks can also be a good choice for the Income Account and Operating Expenses Account.

Why Use Actual Bank Accounts or Spaces, Rather than Just a Spreadsheet?

It’s important to use actual bank accounts or Spaces, rather than just a spreadsheet because physically moving money into different accounts creates a behaviour change. It’s much harder to ignore a physical bank account balance than it is to ignore a number on a spreadsheet. By using bank accounts to separate out different aspects of the business finances, business owners can get a better handle on their cash flow and prioritize profit in their financial planning.

Should I open any more Profit First Accounts?

In general, the five Profit First bank accounts (Income, Profit, Owner’s Compensation, Operating Expenses, and Tax) are sufficient for most businesses to implement the Profit First system successfully. However, there may be instances where opening additional accounts can be beneficial.

The expression often used in the Profit First community is “if in doubt, open an account”. This means that if you’re unsure whether a certain expense or income stream should have its own account, it’s better to err on the side of caution and open a separate account.

For example, if your business has multiple income streams, it may make sense to open separate Income Accounts for each stream. This can help to provide more clarity on where your revenue is coming from and make it easier to track profitability on a per-stream basis.

Similarly, if your business has significant expenses that are separate from your operating expenses, it may make sense to open separate accounts for these expenses. For example, if you have high marketing expenses, you may want to open a separate Marketing Account to track these expenses separately from your other operating expenses.

If you’re using a bank that offers “spaces” like Starling Bank in the UK, it’s easy to open additional accounts without having to go through the process of opening a new bank account. This can make it easier to implement the Profit First system and track your finances more effectively.

In summary, while the five foundational Profit First bank accounts are sufficient for most businesses, opening additional accounts can be beneficial in certain situations. When in doubt, it’s better to open a new account to provide more clarity on your finances and make it easier to track your profitability.

In conclusion, implementing Profit First in your business can help you prioritize profit and simplify your financial planning. By using separate bank accounts to manage cash flow, you can focus on what’s truly important: profitability. Whether you choose Starling Bank, Monzo, Mettle, Tide, or a traditional bank, having separate accounts for income, profit, owner’s compensation, operating expenses, and tax can help you achieve your financial goals and build a profitable business.

Want more resources to get started with Profit First?

You can access our one-page action summary to get started HERE

Top 5 Bank Accounts to Use the Profit First System

If you’re a business owner, you know the importance of managing your finances. But have you heard of the Profit First system? It’s a revolutionary approach to managing your finances that prioritizes profit over expenses. In this system, you allocate a percentage of your revenue to profit, and then use the remainder for expenses. It’s a simple yet effective way to ensure that your business is profitable, and it’s gaining popularity among entrepreneurs worldwide.

One crucial aspect of implementing the Profit First system is choosing the right bank account. You’ll need a bank account that makes it easy to allocate funds to different categories, such as profit, expenses, and taxes. Here are the top five bank accounts to use the Profit First system:

Starling for Profit First

Starling is a UK-based online bank that’s gaining a reputation as a top choice for business banking. It’s perfect for Profit First because it enables you to open multiple accounts under one primary account. These sub-accounts can be named to match your Profit First categories, making it easy to allocate funds to each category.

Monzo for Profit First

Monzo is another UK-based online bank that’s perfect for implementing the Profit First system. It works in a similar way to Starling, with the ability to open multiple accounts under one primary account. This makes it easy to allocate funds to different categories and manage your finances effectively.

Tide for Profit First

Tide is a UK-based online bank that’s specifically designed for small businesses. It offers a range of features that make it perfect for Profit First, including the ability to open multiple accounts and name them according to your Profit First categories. You can also set up automatic transfers to ensure that your funds are allocated correctly.

Revolut for Profit First

Revolut is a digital banking app that’s perfect for those who want to manage their finances on the go. It offers a range of features that make it easy to implement the Profit First system, including the ability to create virtual cards and set spending limits. You can also open multiple accounts under one primary account, making it easy to allocate funds to different categories.

A Traditional bank for Profit First

A high street bank such as Santander or Barclays If you prefer to use a traditional bank, you can still implement the Profit First system. Many high street banks now offer online banking features that make it easy to open multiple accounts and manage your finances effectively. You can set up automatic transfers to ensure that your funds are allocated correctly, and you can name your accounts according to your Profit First categories.

In conclusion, choosing the right bank account is crucial to implementing the Profit First system effectively. The first four on this list are all fintech-style banks that enable you to use spaces with one real account, making Profit First much easier to implement. However, if you prefer a traditional bank, there are still options available to you. Whatever your preference, be sure to choose a bank that makes it easy to manage your finances and allocate funds to different categories.