Today’s guest is one of my favorite repeat offender, Mike Michalowicz. Mike has recently updated his book Profit First and that’s the topic of our conversation today.
Too often you put profit last on the list of important things in your life. You may have read that you should always pay yourself first. That’s the premise of Profit First. By having a specific system for paying yourself first, you’re more likely to put together a method for having enough cash for the important things in your business.
One of the areas of sustainability that too many business owners lack is having enough profit to provide for lifestyle, savings for retirement, cash for an emergency fund and cash to grow the business. Adopting the Profit First strategy will help you have enough cash for all four areas of the sustainable business.
Here are just some of the things you’ll learn in today’s episode:
- How margarita’s and Mike go hand in hand.
- Why profit should never come last in your life.
- How using profit first helps you understand how much money your business needs to make to be sustainable.
- How Profit First is a system that’s built around normal behaviors that you have.
- Learn to develop an easy way to make sure you have enough cash on hand to pay your taxes.
Narrator: Welcome to The Sustainable Business Radio Show podcast where you’ll learn not only how to create a sustainable business but you’ll also learn the secrets of creating extraordinary value within your business and your life. In The Sustainable Business, we focus on what it’s going to take for you to take your successful business and make it economically and personally successful.
Your host, Josh Patrick, is going to help us through finding great thought leaders as well as providing insights he’s learned through his 40 years of owning, running, planning and thinking about what it takes to make a successful business sustainable.
Josh: Hey, how are you today? This is Josh Patrick and you’re at The Sustainable Business.
You know, today we have a repeat offender, Mr. Mike Michalowicz. Mike is just one of the most interesting guys I’ve ever had the pleasure to have a conversation with. I’m looking if the first paragraph of his author’s page on Amazon. And I’ve got to read this to you because it’s too good. “By his 31st birthday, Mike Michalowicz had founded and sold two multimillion-dollar companies. Confident that he had the formula of success, he became an angel investor and proceeded to lose his entire fortune.” Boy, does that resonate with me. I didn’t lose everything that I made because I never made a fortune in the first place. I lost enough to get my attention.
And Mike is the author of lots of books: The Pumpkin Plan, The Toilet Paper Entrepreneur, Surge, Profit First. But today, we’re going to talk about the revised and expanded Profit First which Mike just published, I think, about a month ago or so. So let’s bring Mike in and learn about what’s different about Profit First from his first book.
Hey, Mike. How are you today?
Mike: I’m good. I’m here. I’m ready. I’m fired up.
Let’s bring it. Let’s do it.
Josh: I’m not going to make you do seal barks like you made me do on your show so.
Mike: That was so funny. You were awesome. Yeah, we make every guest that comes on my show to do some things zany to get them uncomfortable. And no one will do the barking or the Chewbacca imitations but you jumped right in on it. And, you know, surprise one of the best interviews because you went right into the meat and potatoes – the good stuff instantly. There was no ice breaking. The ice was broken with the seal barks.
Josh: You know, I think that we actually broke the ice over some margaritas—
Josh: — at the Writers’ Workshop—
Josh: — that you tried to jam down my throat but I refused so.
Mike: That’s true. Did you not drink? Why? What was going on?
Josh: No, no, I drink wine. I’m not a big— I got really sick on Tequila when I was 18 years old.
Mike: Oh, forever hold your peace.
Josh: Yeah. So forever it’s been off my list of things I drink at any level, more than like a sip once in a while so.
Mike: Well, you missed out on some good stuff but—
Josh: I’m sure I did but I’ve also missed on stuff but there you are so.
Josh: So tell me about your new and expanded – revised and expanded Profit First. What’s different this time? Or better yet, why don’t we go into the old Profit First for a second—
Josh: — and then you can say what’s new about the new Profit First?
Mike: Sure. So the original Profit First challenged the axiom – the belief that profit comes last. And we use terms for this. We call it the bottom line, the year end, the final take. And there’s a formula that supports it. It’s the foundation of GAAP accounting. It says, sales – expense = profit. And I called bull wash on that because the reality is the vast, vast majority of small businesses – most businesses are not profitable. Particularly, small business.
And I heard a study of roughly 83% of small businesses survive check by check. I heard a study that 50% of businesses go out of business within five years because of cashflow. They run out of money. And my own experience working with [inaudible 00:03:48] entrepreneurs now, that is the case, so maybe it’s just a struggle.
And so, if that formula was true, sales – expense = profit, wouldn’t businesses be profitable? And what I believe, adamantly, is that formula is an abject lie. Not that mathematically it’s wrong but behaviorally it’s wrong. So in Profit First, what I teach is a new formula. It’s sales – profit = expenses. And what I’m saying in this formula is, if we take our profit first– it’s basically the pay yourself first principle by the business. The expenses then are the remainder. We have to reverse engineer that profitability if we take our profit first.
And, mathematically, I feel that the equations– I’m just switching variables here. Mathematically, it’s the same. Behaviorally, the impact is nothing short of radical. And I believe now— it’s an optimistic estimate but I think, in the degree of realism, is that 30,000 companies are now doing Profit First. And we have thousands of documented stories to back it.
Josh: Wow. So, can I add something to your Profit First think because this kind of fits in?
Mike: Absolutely not. You don’t margaritas. You can’t add anything.
Josh: Well, I’m going to anyhow, so there.
Mike: Okay, then you can. Then you can. Yeah. I mean, it is your show.
Josh: It is my podcast after all.
Josh: You know, for years, I’ve been working with the concept of cost of capital which nobody in the private business world understands or at least people who operate businesses. So I’ve been trying to figure out a way of explaining cost of capital in a way that makes sense. And your book helped me with that immeasurably because it’s not just that businesses don’t make enough profit, they don’t make enough profit to be sustainable.
Mike: That’s right.
Josh: Meaning that – yeah, most businesses are around for five years, so provide a lifestyle for the owner but they don’t get enough cash for security fund. They don’t have enough cash to grow. And they don’t have enough cash to fund a retirement plan adequately for the owner.
Now, the interesting thing about that – just, you know, I’m sure you never think about this but I do, is that when you add those four things together, that’s about the amount of money you need to cover your cost of capital in a small business. So I want to thank you for that because it’s made it really simple for me to explain to clients this impossible concept of how much money you need to make to have a sustainable business.
Mike: Well, it’s my pleasure. And I think entrepreneurs get it when they get to see it. You know, most entrepreneurs that I meet revert to what I call bank balance accounting. Now, here’s what it’s not. It’s not traditional accounting. Traditional accounting, we’re told, read your income statement, your balance sheet, your cashflow statement. Tie them in together. Read the metrics. Read the KPIs blah, blah, blah.
And so, entrepreneurs say, “Well, hold on. I’m going to take a shortcut. I’m going to login to my bank account, see my balances and then I know where I stand.” And the accountant quivers when they hear that. They say, “No, no, no. For God’s sake, don’t look at your bank account because it’s not representative of where business is. You must read these documents.” Well, accountants have been telling this ad nauseam for centuries now and it’s never worked.
So what I decided with Profit First is, let’s build a system around our natural normal behavior. How can we make logging into your bank account and checking out your bank balance advantageous? And what I did in Profit First was really simple. I used the envelope system because this system has been around for centuries and centuries. Take money, pre-allocate it to a purpose.
In a home life, it’d be like allocating money towards food, allocate a portion of money towards paying your mortgage, allocate money towards your car, allocate money towards your expenses or an emergency. And by allocating money to these different categories – if I just grabbed that food envelope and go food shopping, I know exactly how much money I have to go with food shopping. It keeps me confined within what’s truly available for that purpose.
So, in our business, most businesses have one bank account. I log into my bank account. I see what my bank balance is in that one account and I’m like, “Okay, I have money to spend or I don’t”. But I often will consume all the money in there because I think I have all that money available, until the next expense comes or the next panic ensues. So we do it at the bank, is we set up multiple accounts. And so, now when you deposit money into your bank, you then allocate it to the different envelopes, if you will. And now, when you log into your bank account, like you always did before, you look at your balances but it’s been pre-allocated so you know what money is available for what purpose. It’s predetermined. And the entrepreneurs act really well when they can visualize and understand clearly what money is available for what purpose.
Josh: That makes perfectly good sense. And I buy into that 100%. And I know tons of other people that do also.
So, let’s talk about your new book. What changed? What did you learn since the first Profit First?
Mike: Yeah, a lot. So, in my first book, some of the concepts were a little complex. I didn’t realize it until I re-wrote the book. The tax component, how do you reserve for taxes and stuff, confuse people. And how to determine how much percentage-wise should go to it. So, I cleaned it up in a big way from the feedback I got.
I included stories. You know, when I wrote Profit First for the first time, there was a very few companies doing it. I mean, I was just writing the book. I had written about it in the Wall Street Journal in the past and some companies I knew of were doing it, but I didn’t know of the few hundred companies or so that were doing profit first. So I was scant on stories.
Well, the new Profit First, the thousands and thousands of companies were doing it so I included the stories. One of my favorites is— this will be it. This will go down in history with me, is there is a baseball team in Georgia that sent me a note in the mail and had a single baseball card in it of the manager. On the back of it, it said, “Profit First saved this team.” And it’s a Minor League team. The baseball team is called the Savannah Bananas. And the manager, I subsequently have met him. I’m actually going down to Savannah next month to throw out the opening pitch at their opening game.
And this guy took Profit First, ran the system in his business and discovered you can’t run a baseball team how most baseball teams are run. It’s not profitable. And so, he slashed costs. He became extraordinarily innovative. He came up with great marketing concepts – including this baseball team name. And this team has exploded in profitability. They eradicated $1 million in debt in one year by implementing Profit First.
Josh: How did they do that?
Mike: So the first thing is to realize that your top line revenue is not your expense budget. This baseball team— let me pick a number. They pull in $3 million a year. Again, it’s a Minor League team. A Major League team bills in $3 million just in concessions at one game. But a Minor League team, say, it pulls in $3 million a year. The owners of these baseball teams say, “Oh, I’ve got $3 million to support my business. And what that means is I’ll spend $3 million.
When, Jesse, the owner of the Savannah Bananas ran Profit First and pre-allocated the money, he took in that 3 million but then divided it up. $500,000, for example, went to profit. He went to paying himself, the team owner – the most important employee. Another percentage was allocated to paying the tax liabilities. He set more accounts which means payroll was covered. And when it was all divided up, he saw that the operating expenses for the baseball team was not $3 million a year. It’s like 700,000 that he has to run the business.
And one example he gave is, if you have a baseball stadium, like they have, and your patrons come to the stadium, you need to have a point of sale ticket system. That’s how you redeem their tickets for entry. And it’s all done electronically. They walk in with their printout and you scan it in.
Those systems- just to buy the base system was somewhere between $30,000 or maybe $50,000. And then you get charged 10% of every ticket fee. So, say, he’s spending 50,000 as an initial investment and another 15,000 or 20,000 a year in tickets. You know, the first year of doing it is 65,000 to 70,000. Well, he ran Profit First and said, “I can’t afford it. It’s 10% of my budget.” So what he did is, he went back to old school thinking and he bought traditional tickets. I mean, literally, physical printed out tickets. But he said, “Now, they had to buy his tickets which– by the way, to print 100,000 tickets cost him $3000. It’s cheap.
Well, he said. “Now, I’m going to make this into a marketing piece. So his tickets are in the shape of a banana. And now, people redeem their ticket when they walk in but they hold on to them as souvenirs. And you see them all over Twitter and Facebook. And you see people carrying their Savannah Banana baseball tickets.
So he slashed costs from potentially 65,000 to 70,000, for this year, down to 3000 and it became a marketing piece for him. By taking his profit first and now being critical of his numbers and finding ways to run off of what’s truly available for the business, it forced innovative thinking. And this guy thinks innovatively. And he eradicated all of his debt. And now, he’s extraordinarily profitable as a result.
Josh: So let me just play devil’s advocate for a second and ask a question that just occurred to me.
Josh: If I do a budget, aren’t I doing the same thing?
Mike: You are doing the same thing but budgets can be manipulated. Budgets are a proactive “what-if” scenario. But then when we’re living it, we don’t say “what if?”, we say, “Here’s my reality. Budget’s out the window. I’ve got to buy this. I have to do this.”
What Profit First does is it’s budgeting, if you will, in the moment. The money actually is physically not available because you’ve allocated it for profit. And you do want that, by the way. You don’t just put the money into a profit checking account. Second step is then you transfer it over to another bank so that temptation to borrow from it is out of sight and out of mind. So, this is real-time, enforced budgeting, not just theoretical budgeting.
Josh: So what it become is, you’re doing budgeting with discipline?
Mike: Absolute discipline, yeah.
The other budgeting doesn’t work. You know, how many businesses do it? I would argue many do the budgeting. Not when they’re running the business but before they open the business – they call it business plan, as the budget for the year. You know, if we do this, we’ll spend money here and we’ll make $10 million in revenue. We’ll make $100 million – you know, they’re very optimistic revenue.
And then, when they start the business, the next day, those realities in the revenue side don’t come true. They say, “Oh my God, we need to spend more money.” And they rapidly crank up their spend based upon what they have. And there’s nothing to control that because the budget was just— it’s like if you go to war, you can plan for a battle as much as you can, as you want. But the second the first bullet flies, everything’s out the window. Everything’s out the window. It can become pure mayhem. There’s some basic strategy but the day-to-day is pure mayhem.
So in our business, if we think we can plan and budget for every nuance of our business, we’re kidding ourselves – we can’t. But then when those nuances happen, panic ensues and we get out of control. That’s why we implement Profit First. It’s forced, real-time budgeting in the moment and you can’t work around it.
Josh: I’ll tell you something. I wish I had run across Profit First in 1976 when I opened my vending company because, man, I spent like crazy because I didn’t understand just doing cash and profit.
Mike: Yeah. Well, let me tell you, I wish I wrote the book in 1970 because I would be sitting on a beach right now, drinking a margarita and riding a boat.
The concept is nothing new, by the way. I didn’t invent something here. This is the envelope system. This is the pay yourself first system. I think I’m just the first guy that said and recorded it. “Hey, that whole system should be applied to business.” And maybe perhaps that’s the innovative thought.
I don’t think I’m the first to sort of think it though. I think other people have thought it but haven’t executed on it the way I did. I created a book out of it. And I think the impact that it’s having is powerful. And I hope, looking forward to the next 30 or 40 years, that this concept lives on because I can see how positively it’s impacting so many people – including myself.
Josh: I can tell you, it’s hugely powerful. And you said that most business knows is budget. My experience is actually the opposite. And because you’re doing your envelope system, it’s a sneaky way to get business owners to budget.
Mike: Oh. Yeah, I think that I mis-spoke how I said it. Most businesses don’t budget once they’re in business. I’m saying, the day before they have that budget. They call it a business plan.
Mike: But that gets abandoned. I agree. It blows me away. I mean, I’ve met with companies that do $30 million, $40 million, $50 million. They don’t even budget. I mean, more of them do as they get bigger. But when it comes to micro business, the small business – no one. It’s all out the window.
Josh: A microbusiness is never budget.
Josh: Never, never, never, never, never—never budget.
Josh: So what else is new in this version, Mike?
Mike: New stories. Simplified taxes.
Josh: Yeah. How did you simplify the tax piece because that’s a complicated piece?
Mike: Yeah. Yeah, it was complicated. I basically explained— well, what I used to say is, depending on your tax code and where you live and blah, blah, blah [inaudible 00:16:15], just start with 15%. This is because I simplified it.
If 15% of your top line goes to reserving money for your personal taxes, and then when your tax bill comes due on your quarterlies or whatever, modify it, change it. And even that gets confusing to people because they say, “Listen, I’m in the 30% tax bracket. You’re saying take 15% of my top line of my business?” “Yeah, because you have expenses in your business that don’t get taxed.” So it still confuses people. But I just said, “Start at 15%, maybe you modify it down, maybe modify it up but we’ve got to start somewhere.” That’s how I simplified it.
Josh: There’s something else also which, you know, you just remind me of something. If I’m in a 30% tax bracket, I’m not paying 30% on all my profits?
Mike: Right. Or your revenue.
Josh: Yes. Or your revenue. What you’re paying is you pay what’s called the average tax rate. So if your marginal rate which is the highest rate is 30%, your total rate, is probably around 17% or 18%.
Mike: Oh, well. Yeah, yeah, yeah. That’s right. That’s right. That’s also true.
Josh: Which is a—
Josh: It’s a hugely big deal that people miss all the time. We use it in arbitrage when we help people sell businesses, actually, because there’s some really nice arbitrage there. So what other stories can you bring to the table, because people love stories about this stuff?
Mike: Oh, yeah. Yeah.
Well, I’ll tell you. I won’t use the person’s name but it was a big “Aha!” and I included it in the book. In the first book, I had what’s called Profit First. And then I had Advanced Profit First. Basically, once you got Profit First nailed down, here are some advanced techniques you could do.
And the one part I use in the advanced process – every reader who is successfully implementing Profit First did this advanced step and people who struggle with Profit First didn’t do the advanced step. So like, what is it?
Here’s what it is. Inadvertently, I said, “You guys have four accounts: profit, owner’s pay (or owner’s comp), taxes and operating expenses. And run your business off that.” But the problem was the management of the flow of money. So money will come in and you put it in your operating expense account and then flow it out. And then what’s available for what? It confused people. So, I added a fifth account, based upon the feedback that I got, and it’s the income account.
And here’s the story. The income account acts as a serving tray. Kind of like, Thanksgiving. Like, Thanksgiving at the Patrick house, I suspect, goes something like this – if you do it at your house. Do you do it at your house or do you go to friends and neighbors?
Josh: We go to other places but that story’s good enough.
Mike: It’s good enough. Even though it’s not factually true, it’s still a great story.
Mike: Yeah. So here’s— if it was at your house, it doesn’t matter where it is but I could see it like this. You pull out that golden turkey on the serving tray. You have your family and friends around the table. Everyone ooh’s and aah’s. And then here’s what you don’t say – you don’t tell everyone, “Hey, just dig off the serving tray. Everyone, just dive in. Carve out whatever you want of that turkey. Just eat up. Every man for himself.” Instead, I suspect, you carve the turkey yourself and you apportion it, meaning, you put it on a tray so everyone can get a piece. You give something to each person so that everyone has on a plate.
Well, in our businesses, we need that serving tray too. Simply, where the food’s going to be presented so that it can be distributed. That’s what the income account is. As money flows into your business, one of the checking accounts is going to be an income account. Every deposit goes there. And then we’ll take a predetermined percentage – we talked about profit, owner’s comp, out and that’s how we kind of carve up that cash turkey and give everyone their percentage. So that’s another advancement or improvement I made in the book, is to have now five accounts – not just four. And one account – the income account, is simply the serving tray. You never pay a bill out of it. It just collects money. And then you apportion it to the other accounts.
Josh: Nice. I like that.
Hey, Mike, we’re about out of time. And I know that people are dying to find out where they can get a copy of your book. And I know you also have a licensing program or a training program for Profit First advisers so you might want to talk about that a bit. And did you read the book to yourself this time, again?
Mike: Oh, yeah, yeah. Of course.
Josh: So, okay, how [inaudible 00:20:08].
If you don’t have time to sit down or read a book, all you guys are driving around in cars, hopefully you’ll listening to this podcast in your car. Listen to Mike’s book in your car. It probably is going to be great fun because you’re so entertaining and engaging.
And so, Mike, how do people find you, your program, the book – all that kind of good stuff?
Mike: My website is my name. It’s MikeMichalowicz.com.
Now, here’s the deal ‘yo. No one’s going to [inaudible 00:20:31] about Mike Michalowicz. I still struggle with it. Here’s the way to get there. And you can remember this one. My nickname was Mike Motorbike in high school, so just type in MikeMotorbike.com. That will forward you on to MikeMichalowicz, my true name site. Then, on there, I’ve got— all the books are available. So you can check them out. Free downloads of the chapters so you can start reading it before you consider maybe buying it. And I used to write for the Wall Street Journal so if you sign up for the site, you can get my ten most popular articles. They are now archived. So if you’re a Wall Street Journal Subscriber, you can get on the archive. But otherwise, they’re available for free when you sign up.
Josh: Hey, Mike, if somebody was interested in becoming a Profit First consultant, how would they go about doing that?
Mike: Oh, yes. So we started an organization called Profit First Professionals. And what we’ve found is the most in demand consulting in the world – meaning, the most desired consulting yet the lowest supply of it, is profit consulting. Meaning, if you interview 100 entrepreneurs and say, “What’s the biggest challenge you face?” It’ll inevitably be profit. They’ll say, “Well, I don’t have enough sales.” “Well, what does that mean to your business?” “Not enough money.” Ah, profit. “We don’t have enough customers. We don’t have enough money flowing through the business. It all translates to profit. So we started this organization called Profit First Professionals to teach consultants, accountants, bookkeepers how to be advisers around profitability to their clients. And so, ProfitFirstProfessionals.com.
And I also have something for you, too. I’ve made this one-hour audio CD course. It’s free. And all you’ve got to do is text me SUSTAINABLE to 44222. That’s the word SUSTAINABLE to 44222. You’ll get a link. You’ll put in your address and we’ll mail the CD to you. You can listen to it in your car just like you’re going to listen to Mike’s book.
So, thanks a lot for hanging around today. This is Josh Patrick. You’re at the Sustainable Business. I thank you so much for stopping by. And I hope to see you back here really soon.
Narrator: You’ve been listening to The Sustainable Business podcast where we ask the question, “What would it take for your business to still be around 100 years from now?” If you like what you’ve heard and want more information, please contact Josh Patrick at 802‑846‑1264 ext 2, or visit us on our website at www.askjoshpatrick.com, or you can send Josh an e-mail at firstname.lastname@example.org.
Thanks for listening. We hope to see you at The Sustainable Business in the near future.