7 Steps to Doing Your Profit First Instant Assessment
The traditional way of accounting for profit is using the formula:
Mike Michalowicz, the author of First Profit, introduced a new method, which flips this method of thinking.
It uses the formula:
Sales – Profit = Expenses
One of the tools he gives is the Profit First Instant Assessment which allows business owners to see how they are currently performing against the ideal situation for a financially healthy business.
Here are the steps on how to do it (and if you are VAT registered, these numbers should be excluding VAT).
Step 1: Find out the actual revenue of your business.
You can find out what the actual revenue of your business is by first taking note of what the total revenue for your business is.
This is the amount of money your business made over the past 12 months. You should be able to find this in your bookkeeping data, or in your last produced annual accounts. If you don’t have your bookkeeping up to date, or you have not submitted accounts, then you can add up all the income received by looking at your last 12 months bank statements.
Next, you want to do the same for any materials or subcontractors costs that your business might have. It is possible that you don’t have either materials or subcontractors (depending on your business model)
Subtract the materials and subcontractors totals from the total revenue. Real revenue also does not include labour costs.
The amount that you get is the real revenue of your business.
The real revenue is not a number you’ll see in your accounts as a summary heading, and it’s not the same (usually) as your Gross Profit. This real revenue term is one that has been developed by Mike for Profit First purposes.
Step 2: In the table below, pick the column that corresponds to your real revenue.
Real Revenue Range
Step 3: Complete the Actual column in the table below with the actual figures from your business for the last 12 months.
Top Line Revenue
Materials and Subs
In this table, the profit number is not the profit in your annual accounts. That is because with Profit First, we are working with cash. Therefore the profit here is actually best calculated as the real revenue minus owners’ pay minus tax and minus operating expenses.
The Owners Pay is the amount you have taken home - that can be via salary, dividends, or Directors Loan Account repayments.
The tax is amounts actually paid in corporation tax (or personal tax if you are a sole trader)
Operating expenses are the total expenses in the business, that you have not already taken into account. They also include any debt repayments that you have made. This number will involve a bit of adding, and calculations to really get to. The easiest way to find it is from cash flow statement from your bookkeeping software.
And now you should have the “actuals” column completed.
Step 4: Use the percentages in the column you chose in Step 2 to fill out the PF% in the table in Step3.
From the table in Step 3, identify which Profit First percentages are applicable for you business, and put those into the appropriate box in the column labelled “PF%”
Step 5: Multiply the Real Revenue number in the Actual column with each PF%. Put the product in the corresponding PF£ row.
Next you want to figure out what the spending for each category (profit, owners pay, operating expenses and tax) should be optimally in your business. To do this, take your real revenue, and multiply by each of the applicable percentages and enter the answer for each category in the column called “PF£”
Step 6: Calculating the “Bleed”
Subtract the PF£ number from the Actual number in each row.
Put the results in the corresponding Bleed column.
It is important to note that it is possible to get negative numbers at this point.
Step 7: What’s the fix?
In the Fix column, write “increase” if the number on the Bleed row is negative. If it is positive, then write “decrease”.
This tells you want you need to do with head category.
If you have “decrease” in operating expense (which is very common when first implementing Profit First) then you need to focus on decreasing operating expenses to make your business financially healthy.
Once you are done with the Profit First Instant Assessment, you can see clearly how your business should allocate its money, where you have been overspending and where your money needs to be redirected to.
Not everyone is a numbers person, but almost everyone could understand things more easily if it was laid out clearly.
This is something that the Profit First Instant Assessment aims to do—also, changing the mindset of putting profit before expenses signals to business owners that it should be prioritised.
Thus, Profit First can be used to ensure business profitability from the very start.