PROFIT FIRST: GET YOUR PRIORITIES RIGHT

PROFIT FIRST: GET YOUR PRIORITIES RIGHT

INTRODUCTION:

If you’re a property investor struggling to maximise your profits, you may have heard of the Profit First system developed by entrepreneur and author Mike Michalowicz. This system involves allocating a percentage of revenue to specific accounts for operating expenses, profit, owner’s compensation, and taxes. While the system has gained popularity among business owners, it’s crucial to understand how it works before applying it to your property investment strategy.

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HOW THE SYSTEM WORKS:

1. Set up separate bank accounts: To implement Profit First, you’ll need to set up multiple bank accounts for your investments. Each account will serve a specific purpose, such as operating expenses, profit, and taxes.

2. Determine the percentages: Once your bank accounts are set up, determine the percentage of revenue to allocate to each account. Percentages will depend on your portfolio size and investment strategy, but a general guideline is to allocate 5% to 15% for profit, 50% to 60% for operating expenses, 30% to 35% for owner’s compensation, and 10% to 15% for taxes.

3. Use the accounts accordingly: Once you’ve allocated the percentages, use the accounts accordingly. The operating expenses account will cover day-to-day costs, while the profit account can be used for reinvestments or distributions.

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CORE BANK ACCOUNTS:

We suggest the following core accounts:

1. Income account

2. Profit account

3. Operating expense account

4. Payroll account

5. Tax account

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INCOME ACCOUNT:

- Used to receive rental income and other revenue

- Account number should be on tenant invoices

- Solely for transferring funds to other accounts

- Emptied every 7th and 21st of the month

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OPERATING ACCOUNT:

- Standard checking or savings account

- Transfers based on a percentage of income, excluding payroll

- Transfers made every 7th and 21st of the month

- If empty, it indicates the inability to cover necessary expenses, prompting a review of costs

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PAYROLL ACCOUNT:

- Transfers based on a percentage of revenue

- Must be an account from which payments can be made

- Transfers made every 7th and 21st of the month

- Payments made on the 25th of each month

- Excess funds transferred to the profit account every 6 months

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PROFIT ACCOUNT:

- Should be a 7-day notice account

- Transfers based on a percentage (starting at 3%, with a target of 15%)

- Transfers made every 7th and 21st of the month

- Dividends paid every 6 months if the account balance is above a certain threshold (sufficient funds to cover payroll for 6 months)

- Funds should never be used for operating expenses

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TAX ACCOUNT:

- Must be a 7-day notice account

- Transfers based on two percentages (15% for VAT and 27% for income tax)

- Transfers made every 7th and 21st of the month

- Payments made every 6 months for income tax and every two months for VAT

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BENEFITS OF THE PROFIT FIRST SYSTEM:

- Prioritises profitability: By allocating a percentage of revenue to a profit account, you’re incentivised to increase revenue and reduce expenses, leading to better financial health for your investments.

- Encourages better financial management: Setting up multiple bank accounts and allocating funds encourages better financial management and helps you stay on top of cash flow, making it easier to monitor expenses and ensure you have funds to cover bills.

- Helps avoid debt: By prioritising profitability and setting aside funds for taxes and other expenses, the system can help you avoid taking on debt, which is especially beneficial for investors with limited access to capital or credit.

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DRAWBACKS OF THE PROFIT FIRST SYSTEM:

- Can be time-consuming: Setting up multiple bank accounts and allocating funds can be time-consuming, especially if you’re not familiar with financial management.

- Requires discipline: The system requires discipline to work effectively. You need to stick to your allocations and resist the temptation to dip into other accounts, which can be challenging for some investors.

- May not work for all investors: The Profit First system is designed for small businesses but may not fit all investment strategies. Depending on your portfolio and business model, you may need to allocate funds differently or use another financial management system.

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CONCLUSION:

Overall, the Profit First system can be a valuable tool for property investors looking to prioritise profitability and better manage their finances. However, it’s important to weigh the benefits and drawbacks and understand how the system works before implementing it. If you’re unsure whether the system is right for you, consider consulting a financial advisor or accountant for their perspective.