If struggling to pay your quarterly taxes or playing catch up with bookkeeping are regular occurrences, you are not alone. For many freelancers, particularly those who identify as creative people, finance is simply not in their wheelhouse.
Catherine Jewell, owner of Career Passion® Coach, fell into this category for 23 years until discovering Profit First, the title of a bestselling book and financial management program that has helped her gain more control of her finances than ever before in her career.
As Jewell shared during Freelance Austin’s July meeting, in Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, author Mike Michalowicz explains that “the only way to fix your financials is to face your financials.”
The challenge: Spending money because it’s there
The problem with the traditional profit formula (sales-expenses=profit) is that profit is an afterthought, and many entrepreneurs simply “fail to put personal compensation into the formula” and “will go months without paying themselves,” Jewell explains.
This could, in part, be attributed to a variation of Parkinson’s Law, an economic theory that work expands and adjusts to fill the time allotted for its completion. In Profit First, Michalowicz applies Parkinson’s Law to managing finances. “If you have more time, you will take more time. If you have more money, you will likely spend more money,” Jewell says.
Therefore, business owners who do not put profit first often spend the money they make before they pay themselves.
How Profit First Works: Pay Yourself First
Profit First transforms the traditional profit model from Sales-Expenses = Profits to Sales – Profit = Expenses.
In other words, Profit First means you pay yourself first. Similar to an employer retirement account in which a portion of an employee’s salary goes into an IRA before a checking account, Profit First removes the temptation to spend money before you pay yourself.
With the Profit First accounting model, a business owner opens five core checking accounts, each with its own target allocation percentages that are based on annual revenue:
- Owners compensation
- Operating expenses
On the 10th and 25th of each month, business owners check their accounts for income deposits then set aside money for their income, tax, profit and operating expenses accounts. They pay their bills as they come in and, every quarter, they determine and distribute their profit percentage and pay their quarterly tax estimates.
Jewell explains that following this process to manage financial accounts creates a habit that eliminates the fears of owning a business – for example, worrying about how to pay quarterly taxes or never really being sure how much profit your business is making.
Profit First “removes temptation – your profit and compensation accounts are out of sight and out of mind,” she says.
Nancy Williamson, an Austin-based CPA with a Profit First professional certification, offered additional insights, such as taking retirement money, life insurance, and emergency expenses from the owner’s compensation fund and paying staff or contractors through the operating expenses fund. She also recommends investing excess money from the operating expenses account in other areas of the business.
Monitoring the operating expenses account regularly, she explains, “is an easy way to see that money is sitting there waiting for me to spend. [Profit First has an] immediate warning system that tells me what I need to do in my business. If I don’t have a lot of money in operating expenses, I know I need to make more income.”
Seeing results: Jewell’s story
Before implementing Profit First, Jewell sometimes used credit cards to finance her expenses and struggled to pay her quarterly tax payments. She paid herself sporadically and varying amounts, based on the balance in her checking account. Most years, she didn’t know if she had profit until tax time.
Now she pays herself “twice a month no matter what,” Jewell says, and she has been able to set aside money for tax payments for the first time. Jewell has also taken a hard look at her expenses and reduced her monthly outlay from $1500 to $500 per month. She does not use credit cards any more for business purchases and even asks vendors if they will set up a monthly payment system.
“For the first time, I feel like I am running my business,” Jewell says. “This has made me feel like a complete winner and given me so much peace of mind.”
Williamson concurred, saying of Profit First, “It was life-changing for me and gave me the ability to make better decisions.” While figuring out your true profit is important for the health of your business, it can also allow for celebrations. Williamson recommends spending 50% on something fun and using the rest to pay down debt or leave in the account.
The only way to fix your financials may be to face them, but you can have fun in the process, too.
For additional information
To learn more about Profit First: profitfirstbook.com.