Understanding the Profit First System for Retail Businesses

One of the first “money” books I read when I started my bookkeeping business was Profit First by Mike Michalowicz, and let me say that it was a game changer in how I manage the cash flow in my business. If you haven’t read the book, I highly recommend it! You can find it on Amazon here.

But, if you HAVE read the book, you probably noticed that it doesn’t QUITE work the same if you have an inventory-based business. So, whether you’ve read it or not, today I’m here to tell you how the Profit First system works, and how you can use it to help manage the cash in your retail business. 

The Profit First System by Mike Michalowicz

The core of the Profit First system is built around 5 primary checking accounts and 2 (optional) savings accounts. If you’re a product-based business, I’m also going to introduce a 6th checking account as well. I’ll talk about how you’ll move money between them in just a minute. But, to start, let’s look at the purpose of each of these in greater detail:

Income Checking Account

This is the checking account you have that you will connect all your payment processors to. That means that all of your Shopify, Paypal, Sezzle, and cash deposits will be made into this account, and ONLY this account. It collects all your income.

Operating Expense Checking Account 

This is the checking account that you will pay all of your operating expenses out of, such as payroll, rent, supplies, advertising, etc… EVERY bill that you pay (except for inventory) needs to be paid from this account.

Tax Checking Account (and optional tax savings account)

This is the checking account that you will be using to set aside some of your cash flow each month to save for income taxes. As a business owner, you may pay up to 30% of your PROFITS each year in income taxes. If you haven’t been saving for that throughout the year, that tax bill can be quite a shock. 

The optional savings account comes into play if you need to have money “out of sight and out of mind” so you don’t spend it. You know your personality better than anyone. Are you gonna be tempted to tap into that tax checking account if funds are low? If so, then you may want to consider moving most of your tax checking balance into a tax savings account at a completely SEPARATE bank, so it’s truly out of sight when you look at your day-to-day primary balances.

Owner’s Pay Checking Account

Depending on your entity type, this may be an unnecessary account, but I’ll still touch on it here. This is meant to collect a portion of your income that you will eventually pay to yourself as a business owner. If you are a sole proprietor or a single member LLC, this account really isn’t needed, and you can transfer the money that you would put in here directly to your own personal bank account.

However, if you are taxed as an S Corporation and you need to pay yourself a payroll, this account can be helpful for setting aside the future wages that you will be paying yourself. (If you want more information on how your entity type affects how you pay yourself, you can read this post here to learn more)

Profit Checking Account (and optional profit savings account)

This is the checking account that you will be using to set aside some of your cash flow each month to help you save for a rainy day. This is also the account that you will use to GUARANTEE that you always earn a profit. 

The age-old formula of Income – Expenses = Profit is flipped on it’s head using this method. Instead, you get Income – Profit = Expenses, meaning that you set aside what you want to have as your profit first (hence, the book name), and you allocate the rest of the money you’ve earned to pay yourself, pay your expenses, and save for taxes.

Just like with the tax savings account, if you’re going to be tempted to dip into this “rainy day fund” when it’s nice and sunny out, then you may want to consider transferring most of this balance to a completely separate Savings account at a different bank. Again, out of sight, out of mind.

Inventory Checking Account

Alright, this account isn’t really in the book, but I think it’s an important addition for retailers. With a product-based business, inventory is obviously a huge part of your business, so I recommend having a completely separate bank account that is used ONLY for inventory purchases. 

(PRO TIP: If you also use credit cards in your business and you want to use Profit First, I highly recommend you have a credit card that you use specifically for Inventory as well, so you can pay for that credit card with the cash in your Inventory checking account.)

How to Move the Cash in the Profit First System

Now that we’ve covered the different bank accounts, let’s talk about how all the money moves between them. I already touched on the first step above, and that’s to make sure that ALL of the money coming into your business is deposited into your Income Account.

Now, the book talks about making transfers twice a month, on the 10th and the 25th. However, in retail, I actually recommend doing them more frequently, as you’re probably buying inventory more frequently. I recommend doing this every Monday as part of your “Money Monday” process.  

Every Monday, you will look at the total balance in your Income Account. The first thing you’re going to do is protect your inventory dollars. You are going to look at what your TRUE cost of goods sold is – the cost of the inventory you SOLD last week (not what you bought), and you’re going to pull that amount out of your Income Account and move it to your Inventory account. The purpose of this is to essentially be able to replenish the inventory you just sold.

If you are going through a season of growth, or anticipated growth, you may want to increase this by a certain percentage each week as well. So, if your cost of goods sold last week was $1,000, but your YTD sales are up 5%, then you may want to transfer $1,050. It’s best to look at your own sales trends to help make this decision.

Once you’ve transferred your Inventory dollars to your Inventory Account, the remaining balance in your Income Account is going to be transferred to the remaining 4 accounts (Profit, OpEx, Tax, and Owner’s Pay) based on a predetermined percentage (I’ll talk about that next)  If you want a spreadsheet template that will help you make all these calculations for you, then you can download it here!

Once you’re done making all these transfers, you should be left with $0 in your Income Account, and you will see the funds available in all the other accounts that essentially act as a very rough “budget” for your cash flow.

Now, every quarter, there are a couple of “extra” steps to take…

First, if you are required to pay quarterly estimated income tax payments, you will use the funds in your Tax account to make that payment. If you’re not sure if you’re supposed to, then please talk with a tax professional. 

Next, you get to withdraw 50% of the balance in your Profit account, and pay yourself a bonus! The only rule to this is that you CANNOT “reinvest” this money back into your business. This money is for YOU, and is meant to pay you for all the hard work you’ve been pouring into your store. The remaining 50% balance will continue to remain in there and act as the rainy day fund until the next quarter comes around.

How to Begin Implementing the Profit First System

First thing’s first – you need to open all of the necessary accounts. No exception. I’ve heard people use the excuse that they just keep track of all the balances on paper, but that completely goes against the psychology that’s discussed in the book. You need to SEE the balances separately at the bank. 

Next, you’ll want to complete what’s called an “Instant Assessment” to see where all your money is CURRENTLY going. You can also find this in the template here. This is where we are going to determine how we need to allocate & transfer our Income Account balance each week to meet our current obligations. 

Finally, set up your allocation template to do the math for you each week so you can easily see what amounts you need to transfer to which account.

If you need help implementing any of this in your own business, then I’d love to chat! Send me a DM on Instagram at @findingfreedomfinancial, and I’d love to chat with you!

Hi, I’m Megan!

Bookkeeping for the retail industry has some unique complexities that take extra time to manage to ensure accuracy. At Finding Freedom Financial Services, I provide done-for-you bookkeeping services for boutique owners that accurately track these complexities for you so you can have more time and focused energy to dedicate to running your stores. If you’re ready to get your time back, apply to work with me today!

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