Rethinking Profit - A New Perspective for SMEs
Posted on 29th January 2024 at 15:58
In the dynamic world of small and medium-sized enterprises (SMEs), the traditional view of profit and cash flow management often needs a refresh.
The Traditional P&L vs. Profit First
Traditionally, SMEs focus on the top line (sales or turnover) and then deduct expenses to determine profit. However, Michalowicz's "Profit First" flips this concept. It suggests that businesses should allocate profits first, followed by the owner's pay, taxes, and then operating expenses. This shift in mindset from a revenue-first to a profit-first approach can significantly change how SMEs manage their finances.
Prioritizing Profit: By putting profit allocation at the forefront, SMEs are forced to operate more efficiently, reducing unnecessary expenses and focusing on cost-effective strategies.
Sensible Owner Compensation: Ensuring that the business owner's compensation is accounted for early in the financial planning process emphasizes the importance of sustainable business growth that benefits all stakeholders.
Profit first is the approach that BizSmart Gloucestershire uses, and it is a key part of how we have become creative, use cash to be very efficient and challenge everything we do every day.
Aligning with the ScaleUp Journey
The Profit First model aligns well with the various stages of the ScaleUp Journey. As businesses grow, their financial structures and needs evolve. The transition from a one-person business to a team and beyond comes with different financial challenges and opportunities. Implementing the Profit First approach can provide a framework for navigating these changes.
Adapting to Growth: As your business scales, the distribution of revenue towards profit, owner’s pay, and expenses can adjust to reflect your business's evolving needs and growth stage.
Creating a Scalable Model: By focusing on profit first, SMEs can develop a more scalable and sustainable business model.
Implementing the Profit First Approach
To effectively implement the Profit First approach, SMEs can start by analysing their current financial state and then gradually transition to the desired allocation percentages.
Bank Account Structure: Setting up different bank accounts for profit, owner’s pay, taxes, and operating expenses can help in managing finances more effectively. In the UK use banks like Starling or Monzo as they have ‘Spaces’ to build different accounts for free.
Regular Allocation: Regularly allocating funds according to the Profit First model ensures discipline in financial management and prevents overspending.
The Impact on Business Strategy and Execution
Adopting the Profit First approach can have a profound impact on various aspects of business strategy and execution. It encourages SMEs to think creatively, plan efficiently, and execute strategies that prioritize financial health and sustainability.
Efficiency in Operations: With limited funds allocated for operating expenses, businesses are compelled to streamline their operations, enhancing efficiency.
Strategic Decision Making: This approach aids in making more strategic and forward-thinking decisions regarding investments, hiring, and business expansion.
Integrating Profit First into SME Operations: A Blueprint for Sustainability
Having established the foundational concept of the Profit First approach, it's time to explore practical ways to embed this philosophy into the everyday operations and long-term planning of SMEs. This integration not only promises a healthier cash flow but also paves the way for a more sustainable and resilient business model.
Operationalizing Profit First
The implementation of Profit First is more than just a financial exercise; it's a complete shift in how SMEs approach every aspect of their business, from leadership development to sales techniques.
Strategic Financial Reviews: Include Profit First discussions in your regular financial reviews. This could be part of your 90-day planning process or monthly financial meetings.
Informed Decision Making: Use the Profit First model to make informed decisions about investments, business expansion, and resource allocation.
Impact on Business Planning and Strategy
When profit is prioritized, it inevitably changes the way SMEs plan and strategize. It encourages a more disciplined approach to business planning, ensuring that growth is not just achievable but also sustainable.
Budgeting with a Profit-First Lens: Align your budgeting process with the Profit First approach, ensuring that every expense is justified and contributes to the overall profitability of the business.
Sustainable Growth Strategies: Adapt your growth strategies to focus on sustainable, profitable growth rather than just top-line revenue increases.
Team Involvement and Culture Shift
Adopting Profit First is not just the responsibility of the finance team or the business owner; it requires a cultural shift throughout the organization.
Educate Your Team: Conduct workshops or training sessions to educate your team about the Profit First approach and how they can contribute to its implementation.
Cultural Shift Towards Efficiency: Foster a culture where efficiency and profitability are valued. Encourage team members to come up with cost-saving ideas and more efficient ways of working.
Reviewing and Adjusting the Model
Like any business model, the Profit First approach needs regular review and adjustment to ensure it remains relevant and effective for your business's current stage and future goals.
Regular Financial Health Checks: Conduct quarterly or bi-annual reviews of your financial health using the Profit First model as a benchmark.
Adaptation to Business Changes: Be prepared to adjust the allocation percentages as your business grows and evolves.
Summary and Key Takeaways
Operationalize the Profit First Model: Embed the Profit First approach into your business’s operational and strategic planning.
Cultivate a Profit-First Culture: Educate and involve your team in adopting a profitability-focused mindset and become creative within the constraints it will bring
Strategic Financial Management: Use Profit First for informed decision-making and sustainable business growth.
Regular Reviews and Adaptations: Continuously review and adjust the Profit First allocations to align with your business's evolving needs.
In conclusion, integrating the Profit First approach into your SME can transform how you manage finances, leading to a more disciplined, efficient, and ultimately more profitable business. This method challenges conventional financial management practices, placing you on a path to not just business success but financial resilience and sustainability.
For more detailed insights into the Profit First approach, SMEs can refer to Mike Michalowicz's book, "Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine."
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