A Different Approach
Most of us think about profits like this: Sales – Expenses = Profit. Now, consider this approach: Sales – Profit = Expenses. Do you see the difference?
The first approach, falls under GAAP (Generally Accepted Accounting Principles) and actually hurts profits. Here’s why. While GAAP is logical, it doesn’t account for the human factor. In the book, “Parkinson’s Law” Cyril Parkinson put forward the idea that “work expands so as to fill the time available for its completion.” We can extract from that a bigger picture concept; that us humans tend to max out whatever a resources is providing.
So what happens is that when the sales come in, we justify the expenses based on the available money. And as for profit? Well, there usually isn’t much left over. This is where a “profit first” approach can be a game changer for your business.
Make Expenses Second
Instead of deducting expenses first, take out what you need for profits first. What you have left over is available for business expenses. This is a powerful concept because it puts you in a place where you may have to think and get creative because their is now a more defined limit to your expenses. The saying, “necessity is the mother of invention” kicks in when we create a necessary limit on our expenses. The self-imposed limitations of taking profits first could create the necessary need for more creative approaches to equipment, marketing and whatever your company might experience due to your self-imposed downward pressure on expenses.
This concept isn’t here to do away with all GAAP concepts. Profit first can sit on top of your other accounting principles, and while it’s not the end all to cash flow problems, it will make profit a habit if you choose to implement it.
As with anything new, I don’t suggest you just dive in and make the change. Think it over. Take some time and go back a few months and play with the idea. What would have happened in those months if you had taken your profit first? See if the idea has merit and if so do something about it.
Watch The Video
Taking profits first is definitely not a traditional business approach. However, traditional does not automatically mean it’s the best. In the following video, Mike Michalowicz explains how he discovered and then utilized the profit first approach to finally run a profitable business. Bear in mind ,he’d previously built and sold 2 multi-million dollar technology companies.
What will you do with your new knowledge? Carry on as normal or implement it? We suggest you at least give it some serious thought. It’s not what you know as much as what you do with what you know.