Chantal: Hey, Mike, welcome back to our final week of the intensive series.
Mike: Week four. I wish I had a horn or something to blow up. I’m so excited.
Chantal: I know. It’s a big deal. It’s a big deal, and it’s especially exciting because today we’re talking about a topic that I think a lot of people want to know about, and that is paying yourself first.
Now, throughout the last three weeks, we have mentioned your book, “Profit First,” and I mentioned the benefits that I got personally out of reading it. One of the big things in the business, of course, is paying yourself first. I thought that in our final week of the intensive series you could maybe talk us through a bit of a step-by-step guide.
Mike: Yeah. Oh, this is what I’ve been waiting for. I’m excited. “Profit First” is the principle that, we’ve already been alluding to it over the last three weeks, of taking your profit first. Why do you do this? It’s a couple reasons. One, it works with our natural tendency to work with bank accounts. We log into our bank, check what our balance is every so often. What I’m saying in “Profit First” is keep doing that behaviour. It’s your best ally. Keep looking at your bank balances.
The second thing is it’s the envelope system. We’re going to pre-allocate money to its purpose, so we’re going to put money into the profit account. I’m going to give you the other accounts in a minute, owner’s comp and so forth. We’re going to put money into these different accounts, and we’ll know before we access the money what the intended use of that money is. That’s very important.
Then the last thing, of course, is by taking our profit first we are reverse engineering profitability, something I talked about last week. Take your money, you tuck it into profit account, and now you are forced to run your business off the remainder and you’re forced to run your business profitably, consistently and permanently.
Here’s the basic steps to staying profit first. I found every business should have five foundational accounts. First account is an income account. This account is a checking account or savings account at your bank. It’s for deposits only, so when people pay you their membership fees or however you collect money, it goes into this account.
Kind of like a dinner that you have with your family, where you take out the meal, you put it on a serving tray. Never tell your family members, “Hey, just eat off the serving tray with that knife and fork of yours.” Instead, you say, “I’m going to serve you off this main tray and put food on your plates.” That’s what the income account is. It’s simply a serving tray of cash. You never, never consume off of it.
What we do is we then allocate to the remaining four accounts. One’s the profit account. That’s money that is going to be for you as a reward. Profit is a reward to owners of a business for taking on extraordinary risk. You started a gym. 99% of the world population doesn’t ever start a business. It’s too scary, too challenging, requires too much effort and too much drive, but you did it. This is a reward for you investing your business with sweat equity and perhaps even money.
The next account is called owner’s comp. The owner’s comp account is money that is allocated to pay your compensation. I call this the lifestyle account. This pays for your lifestyle. You are an owner of the business and you get profit for that, but you’re also an owner-operator, and that’s what your compensation is for, for operating the business.
The next account is called a tax account. I think in Australia it’s June 30th. In the States here it’s April 15th. When that tax bill is due, you’re digging through your wallet, you’re digging through your purse trying to find money, and panicking. The definition, in part, of financial freedom is that the business addresses all your financial responsibilities, including your taxes.
Your business is going to reserve a portion of that income to your tax liabilities, and taxes … Specifically I’m talking about income tax. I also realise in the States we have sales tax. In Australia you have GST. Those would be separate, additional accounts we could set up too, but these are just the five foundational I’m talking about.
The last account is called the operating expense account, or op-ex, and this is what you run your business off of. What we do when money flows into the income account, we use predetermined percentages. Over the last three weeks we started figuring out your profit percentage. We’re not going to have time on these trainings, but I have a free download. You can just, I’m sure, Chantal, you can share, but there’s a free download where you can get suggested percentages for different size companies.
You have to figure out allocation percentage for each account. Then, as money flows into the income account, you divide it up so you share it so it drives home. This is the envelope system. This is something my mother did. I guarantee someone in your family tree has also done this, that when my mother worked, she would receive her check and then she would cash in that check and divide the money up into different envelopes. One was a food envelope, one was the mortgage, one was to give back to the community and to the church and so forth.
The food account, or the food envelope, my mom would go to the store and she’d make do with what was in there. Now, she always had enough money to buy food, but I don’t want you to confuse having enough money with having the same amount of money. You see, the percentage of income for her varied. Sometimes she was sick, sometimes she’d work overtime.
Therefore, the amount going into each different envelope would vary, because it was a percentage-based system. When she had less money in the food envelope, she would buy cheaper food. When she had more money, she’d either store some away for future needs for food, or she’d buy, sometimes, a treat.
The lesson’s the same for our business. As money flows to the different accounts, the operating expenses, it’s just a percentage of the income. If our income varies, and it will, so will the operating expenses. We have to be able to live off of the lower threshold of our operating expenses, and when there’s more money in the operating expenses, queue some up for a little bit for the future, or maybe you can buy that one piece of equipment, but you must live within your operating expenses.
I have a final lesson here. If you look at your operating expenses and then you look at your bills, and you can’t pay your bills, when you can’t pay your bills you can’t afford your bills. That is your business giving you direct feedback that you must adjust your business, you must reduce expenses or increase margin, meaning more profitable at the top line, so that you can afford your bills. If you can’t pay them, you can’t afford them and you must adjust your business.
Chantal: Mike, over the last four weeks you’ve talked to us about financial management, we’ve talked about improving cash flow, reducing expenses, and today of course how to pay yourself first. We’re going into a new financial year, 2018. Tell us one last thing. People have learnt a lot. You have taught us so much over these past four weeks. How can we stick to our New Year’s financial resolutions?
Mike: Yeah, so I gave you this system, then I’ll get you started. Set up these accounts, but the big thing is get an accountability partner. Listen, you’re gym owners. You get this more than anyone. If I want to be successful at the gym, if I hire a trainer, the chance that I’ll have success getting physically in shape, improving my health, increases dramatically, when I’m accountable to someone that knows what they’re doing.
Find an accountability partner, working with someone else, or find an accountant or bookkeeper who specialises in profit first, and that’s the ultimate trainer. Do one or the other, either, or do both, and I promise you, when you’re working with someone else the chance of your successes skyrocket.
Chantal: Mike Michalowicz, you are quite amazing. Thank you so much for joining us over these past four weeks of the intensive series. We are going to put all of your contact details, the details of your books and your podcast, in today’s show notes. I want to say thank you so much, on behalf of the FBP family, for joining us for this intensive series.
Mike: It’s been my pleasure and a joy. Thanks.
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