How to set up Profit First with a hybrid model

Do you want to set up profit first and get the benefits, make it quick and easy and not overcomplicate it?

The problem is, many business owners want to set up Profit First but never get around to it because they think it can’t work for their business. They want their system to match exactly what the book suggests with fixed percentage allocations to separate accounts. However, with variable sales each week, it seems like Profit First won’t work as in some weeks fixed costs such as staff wages may not be covered by the percentage allocation. In these cases Profit First is either tried and dropped or not started and in both cases, the benefits of Profit First are not realised.

In this environment, business owners typically remain frustrated and feeling out of control regarding cashflow. This shouldn’t happen as with a few quick adjustments, Profit First can still work regardless of how sales fluctuate. Although there’s no doubt that managing cashflow for any business can be challenging, having seen these adjustments work, it shows that the key to setting up Profit First in these cases is a hybrid model with both percentage and fixed amount allocations.

If this is your business and you want to set up Profit First with a hybrid system, follow the three steps below.

Step 1 – Remember the key principles to set up Profit First

It can be a mistake to think that you need to set up percentage allocations for every type of expense in order to follow Profit First. Profit First’s key principles are to pay profit first and reduce the funds available for general spending by allocating funds to separate accounts. You can follow these principles as long as you have a system to pay either a fixed or percentage amount to a profit account at regular intervals.

Step 2 – Consider a hybrid system

Many businesses won’t be able to afford to pay fixed operating costs if their sales are low for a week and they transfer a percentage of sales to an operating expense account. To overcome this problem, a hybrid model that transfers

1. a percentage amount to a Profit account,

2. a percentage amount to GST,

3. a percentage amount to a variable cost of sales account,

4. a fixed amount to an operating costs account, and

5. any remaining balance to the Profit account may work.

In this instance, you have still paid profit first, covered variable cost of sales, ensured fixed costs are paid and covered GST.

If your cash sales for the week are low, then you have the option of reducing the Profit amount and/or reducing your own wage. If sales are high, then the fixed amount for operating costs ensures that you don’t have a surplus in your operating costs account which can lead to higher spending. If your own wage is included in the operating costs account, then a fixed amount will also mean your own wage doesn’t fluctuate and you can plan and manage your personal spending.

What a hybrid system looks like

The table below looks at how it can work with different sales receipts, with

• percentage allocations for an initial payment of profit, variable cost of sales and GST, and

• fixed allocations for general overheads and owner’s wage

• remaining allocation to profit

In this first column with $5,000 of sales, the business will need to reduce the owner’s wage amount by at least $450 to ensure other costs are paid. In the second and third columns, as sales increase, the amount allocated to the profit account increases after the initial 1% has been transferred.

Step 3 – Design your own hybrid system to set up Profit First for your business

Now that you have an idea of what a hybrid system looks like, it’s time to consider what you need to do to make it work for you. There’s a bit of preparation involved. Specifically, you will need to go through the following five steps to set up your system and ensure it keeps working for you;

1. Determine your percentage allocations for profit, GST and variable cost of sales.

Determine your initial profit percentage and start with at least one percent. You can go through the ‘instant assessment’ process to help you with this.

Determine the GST percentage by reviewing previous BAS’s and calculate net GST as a percentage of sales including GST.

Determine your variable cost of sales percentage by reviewing the profit and loss statement or as part of the instant assessment process.

2. Calculate your fixed overhead costs by reviewing the profit and loss statement and past spending, whilst also considering any likely changes. Calculate your wage based on your personal spending requirements.

3. Plan for how you will manage fixed overheads including your wage if your sales are low. Will you reduce your wage or will you draw on a reserve account?

4. Set up a table in a spreadsheet similar to the table above, so that each week you can enter the sales figure and the allocations will be automatically calculated. Ensure you do the transfers and if there are any problems such as unexpected expenses, consider the use of a reserve account and whether you need to adjust any percentages or fixed amounts for future weeks.

5. Conduct an overall review at the end of each month to ensure your percentages and fixed amounts are still valid or whether they need to be changed. Review the amount in your profit account and consider whether the profit percentage could increase, so that you can make quicker progress towards your financial goals.

Your end result

Many businesses struggle to both manage cashflow, make consistent profit and pay off debt, whilst others try and set up Profit First but find it doesn’t work with their variables sales. A hybrid system will give you the benefits of paying profit first with an easy to use, clear structure. It will ensure overheads and owner’s wages don’t blow out if sales are high but conversely, these costs can be  catered for if sales are low. More consistent profits and easier cashflow management will give you confidence, a feeling of being more in control and start helping you achieve the success you went into business for.

Want assistance

Want to set up Profit First but feel like you could do with a hand? Book a free initial zoom call with this link to my calendar and we can go through any issues you may have and start working out what your next steps need to be. Alternatively, do one of the online courses on how to set up Profit First at https://www.morrisonabs.com.au/online-courses/