Profit First For Bankers

In a crowded marketplace, fitting in is a failure. In a busy marketplace, not standing out is the same as being invisible. – Seth Godin.

As the commercial banking industry races towards commoditization in the name of efficiency and customer focus (which is not a bad thing, mind you); the role of the commercial banker is at a cross roads. I believe that the banker of the future, is like Tony Stark in his MK42 Ironman suit. A master that is comfortable doing what he does best, while maximizing technology to do what it does best.

But whose technology? Personally, I don’t like the idea of leaving my fate to the technology that is used by my employer, do you? So, in addition to mastering technology, I believe that critical to the success of MK42 bankers, is the development of a personal brand – which allows them to stand out and attract the clients that get maximum value from working with them. This personal brand must be unique, genuine, and multi-facetted.

For example, I have been developing my personal brand – The Entrepreneur’s Banker for over 2 years. I tell clients that I help them to INCREASE their profits, STRENGTHEN their leadership skills, and DEFINE their strategic vision.

It is that first promise that I want to talk about – INCREASING PROFITS.

In addition to being The Entrepreneur’s Banker, I am 1 of 2 Certified Profit First Bankers IN THE WORLD. I want to tell you all about Profit First, and how it can help you as a banker. You don’t have to become a certified Profit First Professional (but I suggest that you do); but this may be one way for you to stand out in the crowd.

What is Profit First?

Profit First is a cash flow management system that empowers entrepreneurs to ensure that at the end of the year they have a real (CASH) profit, not just an accounting profit. Additionally, it ensures that they have cash on hand to pay the friendly neighborhood tax collector AND that the business generates enough cash to provide for the most important employee aka the owner.

Profit First has 3 major rules that provide the strength to the system:

1. Parkinson’s Law, which basically says that “work expands so as to fill the time available for its completion.” When you apply it to finances – “expenses expand so as to fill the cash available for its consumption”. So, if an entrepreneur has $100,000 in their account to spend each month, it should be no surprise that they will find a way to spend all of it (most probably find a way to spend more than the $100,000).

How Profit First takes advantage of this law is that we reduce the amount of cash that is available for the company to spend on operational expenses by “taking cash off the top” and designating it to Profit, Tax and Owners Compensation and only what is left over is allowed to be spent on operational expenses.

2. Multiple Accounts. The actual mechanism that the system uses is to open up multiple accounts. There are 5 basic accounts, but this system can be customized for any business.

• Income Account: ALL deposits are made into this account, similar to a collateral reserve account in an ABL discipline. Twice a month, the cash that is accumulated in this account is allocated to the remaining 4 accounts, based upon a predetermined percentage.
• Profit Account: this account holds the CASH profit. Once a quarter this balance is brought to $0. The owners can:

1. Take a distribution (just like a quarterly dividend check that your bank pays its shareholders).
2. Increase their cash reserve
3. Pay down debt
4. Invest back into the business
5. Set aside cash for expansion, purchase of new equipment, a new hire, etc.

• Tax Account: this account holds the cash that is owed to everyone’s favorite silent partner – Uncle Sam.
• Owner’s Compensation Account: this account holds funds designated for the most important employee. How many times have we seen entrepreneurs running multi-million-dollar companies; but yet they pay themselves less than minimum wage? A business that can not sustain the lifestyle of the owner is a hobby.
• Operational Expense (OPEX) Account: this account holds the remaining cash and the business has to live off of this amount for 2 weeks. If the owner allows the business to consume more cash than what is in this account, then they are stealing it from either their Profit or the Owners Compensation; because we all know that Uncle Sam is going to get what is due to him.

3. A systematic review of expenses and an increase in profitability. Every quarter the entrepreneur sets a goal to “tighten the belt” a little bit more and take a few more percentages out of the OPEX account and put it into the other 3. This is done through discipline, creativity and grit – all characteristics that entrepreneurs have demonstrated in spades since the beginning of 2020. When a business is starting out and doesn’t have $10,000 a month to spend on google ad words, the entrepreneur finds a creative way to get their name and brand in front of their target clients. Every dollar is precious, so the make every dollar spent have the impact of ten. This is hard work, exhausting work, and I completely understand why, after some success, entrepreneurs want to “increase the budget” and not scrutinize every single penny of expense. Most often this leads to expense bloat and entrepreneurs start lying to themselves to justify the expenses (“that is just the cost of doing business”, “you have to spend money to make money”, “I’m just reinvesting all my profits back into the business”).

Done properly, Profit First allows entrepreneurs to have more financial freedom than they ever could have imagine. If you want to learn more detail about this system, you can check out this video.

But what about you, a banker. What is the benefit of Profit First to you?

1. More accounts and a “stickier” relationship. We all know that it is difficult to move from your current bank; and the objective of most banks is to provide as many services as possible so that the client sticks with you. Imagine the stickiness to move if you had 5 accounts to move, not just 1.

2. Higher average collected balances. A myth that I often dispel to entrepreneurs is that it is not the amount of cash run through an account that matters to a bank. It is the average collected balance that matters. The profit account feeds the strategic reserve (which is literally cash that is sitting there for a rainy day). The tax account just sits there as well. So instead of churning that cash constantly in the OPEX account, more of it sits on your bank’s balance sheet. This really starts to impact your bank’s bottom line as this lowers the cost of capital and puts the bank in a stronger cash to loans ratio.

3. More cash on your customer’s balance sheet. Just think about all the benefits you get from this. You can probably get more loans approved for these clients, at more flexible and competitive rates (because overall the bank is making more money on the relationship). Because they can use their profit distributions to pay the loans off faster, they will be in the position to borrow more from you.

4. More cash means a lower credit risk profile, which in turn helps your bank by lowering their provision for loan loss on this client. It also means that customers have the financial flexibility to deal with unknown events (like a pandemic), which keeps their loan from being downgraded or classified. This of course is a great thing for the client; but any banker that has had to manage a troubled loan knows what an emotional and soul-sucking experience that is.

5. Personal wealth management. When clients transform their business into an ATM, they have to put that money somewhere. Many of them realize that their business is the riskiest part of their asset portfolio; so they take some cash out of the business and start to accumulate a personal balance sheet. Many banks have wealth management divisions for high net worth entrepreneurs. This is another way you can increase your value to entrepreneurs (ie. stickiness) as well as the income to your bank.

6. The most fun conversations. When entrepreneurs have a fully funded cash reserve, a business that prints profit, and enough cash to give Uncle Sam his “taste of the business”, they start to dream. For me, this is the best type of conversations. To see them take a white board and fill it with possibilities; and to be able to be part of that process and speak into how they are going to accomplish their vision. I don’t know about you, but THAT is a huge benefit of Profit First!!

I know what you are thinking, if this is so great – why doesn’t every entrepreneur do this. EXACTLY! I really do believe that every entrepreneur needs to adopt. But not everyone does; and not every banker sees the value of this system. Here are the top 4 objectives that I have heard from entrepreneurs (and bankers) alike.

With all those accounts – wont they be fee’ d to death? Depending upon the fee structure and qualifiers needed to avoid service fees – Yes. At least once a week there is a new thread on the Profit First Professional’s closed FB group asking about Profit First friendly banks. So how your bank ranks is already known. Depending upon your bank’s structure, you may be able to waive these fees. Believe me, it is worth it.

               Let’s nerd out a bit on the actual accounts, and what you need to be aware of:

• Most of the accounts have low volume activity. Most of the time, only the OPEX has more than 50 transactions per month.
• All deposits are made in the Income account (so this is the only one you need to bother ordering deposit slips for).
• Because it is the only account that writes checks, sends cash out of the business, and has drafts come out of it, the OPEX alone will needs access to “sophisticated” services such as wires, ACHs, fraud mitigation. Obviously, this is the only one you need to worry about ordering checks and debit cards for.
•  The most basic online banking platform will be acceptable, as the bi-monthly transfers from the Income account to the other accounts is a critical step.
• The book recommends having a separate bank (one that is extremely inconvenient) hold the Profit and Tax funds. I have found that entrepreneurs break down into 3 basic categories. The type that is disciplined enough not to touch the Profit and Tax accounts and doesn’t need any help. The type likes to see the account balances build up, but needs you to put an administrative hold on the accounts to keep their “hands out of the cookie jar”. The type that wouldn’t trust themselves with a $5 bill that they found on the street – for these you can simply hid the Profit and Tax account from their online view. Of course, the last 2 types have to fully agree and authorize you placing a hold or hiding their accounts. I find that these tricks make accessing these funds inconvenient enough that it gets the job done; but still keep the balances at your bank.
• Just like with any account transition process, it takes time. I would recommend waiving all service fees for the first 90-days. This will allow you and the entrepreneur to get to know your system, processes and operational quirks. After 90-days, set up a meeting to go over the account activity, identify issues that may cause unexpected fees, and implement solutions to minimize or eliminate the fees.

Having all those accounts are going to make it difficult to reconcile and the client’s accounting bill will go through the roof.

First, why don’t you let their accountant or bookkeeper make that determination. Second, no it won’t. While there are more accounts to reconcile, 1 (Income) that has all the deposits and only 2 withdrawals per month, 2 of them (Profit and Tax) have 6 transfers in and 1 transfer out a quarter, the Owners Comp account has 6 transfers in and a maximum of 12 transfers out a quarter, and they are already reconciling all of the expenses run through in the OPEX account already. So while it may be more accounts, it is not fundamentally more difficult or dramatically time consuming than the current amount of transactions.

Wouldn’t it be easier if they just had 1 account and then used their accounting software to split it up?

I am sure you have heard the definition of insanity: “doing the same thing over and over again an expecting a different result”. If operating out of 1 account has not ensured that they are permanently profitable by now, it probably isn’t going to work in the future. One of the most powerful aspects of this system is that it leverages human nature. If an entrepreneur pulls up your bank app and looks at their account and sees $50,000; they think they have $50,000 to spend. They don’t pull up their QuickBooks General Ledger and realize that out of that $50,000 all but $15,000 is already set aside for Profit, Taxes and Owners Comp.

This is a system that only struggling businesses should use. This is too much work for profitable businesses.

Profit First is used by thousands of businesses ranging from start-ups to 8-figure revenue companies. It is all about ensuring that only the proper amount of expenses is being authorized. While it is true, companies that have a strong balance sheet and a proper amount of working capital and reserve don’t feel the pain that other businesses feel. But if an entrepreneur could put an additional 3% of sales in their pocket as an annual distribution – I bet they would like that (no matter how profitable they are now). 3% of an 8-figure business is REAL money.

I am not saying that every commercial relationship manager needs to become a Certified Profit First Banker; but I am saying that this system is beneficial to the entrepreneurs you serve, you, AND your bank. I would highly recommend that you read Profit First (get your copy HERE) and find out if there is a certified Profit First Professional near you and meet with them to learn more about this system and explore how you can support them and their clients. (Word of warning – these are all very experienced and savvy entrepreneurs – do not try to sell them on you and your bank.) You can find a local PFP HERE. If you want to talk more about how you (or your bank) can use Profit First to help your clients – DM me. I am happy to share my experience and help you and your clients.

Greg Martin is a former Airborne Ranger that has been a banker since 2006. He firmly believes that every person is uniquely crafted by God to accomplish something special. When he is not helping clients, he is nerding out by watching Marvel movies and playing with his amazing son and supremely talented wife of 18 years. For more content, check out his personal blog at www.theentrepreneursbanker.com.