How to Use PROFIT FIRST to be More Profitable (for Ecommerce Sellers)

Profit First flips the script in their approach. Sales minus profits equals expenses. Essentially, you take your profits out of your sales and use what's left over to run the business. Sounds simple, right? In my opinion, Profit First is a mindset as much as a practice. You don't become profitable by simply allocating profits from your sales.

0:44 The five accounts and allocations

Let's walk through the practices involved with Profit First, then I'll give you my insights.

Step one, set up multiple bank accounts. Each account will have a specific purpose. Profit First recommends five accounts. Income, profit, owner's pay, taxes, and expenses. It also recommends two savings accounts, your profit holding account and your tax holding account.

Next, as you get paid, you're gonna allocate your income into those various accounts. So let's take an example. You make $10,000 in sales. You allocate 10% to your profit account, 30% to your owner's pay, 15% to taxes, and the remaining 45% to expenses.

The idea with the profit and owner's pay accounts is that you carve out some of the income so that you ensure that you as an owner are getting paid. Mike, the author, tells some painful stories about how he came to this conclusion with his own businesses, and this approach ensures that you are getting paid as an owner first, thus Profit First.

With the owner's pay account, you pay yourself twice a month depending on your business. This can come in the form of payroll or distributions. The operating expense account is what you use to run your business. Easier said than done, but I'll get into this later.

1:44 Reviews, transfers, and CAPs

Profit First recommends reviewing your balances daily to see what's happening from a cashflow perspective. Also, twice a month, Profit First recommends that you do your allocations into your various accounts. It then recommends that you take the balances from your profit and your tax account and move them to your savings accounts in another bank. The idea here is those funds aren't needed to operate your business, so you want 'em out of sight and out of mind, so there's no temptation to use them in a different way.

Next, Profit First recommends that you pay yourself 50% of what's in your profit holding account quarterly, and then any taxes that are due you pay from the tax holding account.

Now, these percentages you use to allocate from your income account to the other accounts, those are known as allocation targets or current allocation percentages, also known as CAPs. These CAPs you should review quarterly and make improvements to be more profitable. Profit First provides guidance on what your CAPs should be based on the size of your business. In reality, you have to come up with CAPs that are reasonable and improve them over time.

Annually, Profit First says you should go over your financials, put some money aside into a vault or a reserve fund, retirement accounts, and do any capital purchases.

2:43 My honest opinion

Now, let me give you my honest opinion on all of this. Implementing the multiple accounts and allocating money is the easy part. Putting a portion of your sales into an account does not mean that you have profits. The key is to figure out how to operate your business within the limits of what you allocate into that operating expense account. This can be easier said than done based on your historic operating approach, your business, and your industry.

Profit First is a mindset as much as anything. One of the things that Profit First talks about is getting rid of all the wasteful spending, and I 100% agree with this. I see a lot of inefficient marketing spend. Improving this is not easy, but it should be a focus of every ecommerce business owner.

I see a lot of excess spending in ecommerce businesses. Too many people on payroll, too much spent on rent, too much spent on vanity things like business trips or meals, things that aren't actually moving the business forward. If you are serious about spend discipline, you should consider Profit First. If you aren't, don't waste your time, keep wasting your money.

3:34 Extra accounts, debt, and inventory

There are a few additional considerations I would make for an ecommerce business. First is the purchase of inventory. I would recommend, at minimum, an allocation of cost of goods sold, or COGS, to an inventory account.

Now, here's the challenge. If you're growing, that inventory account will not fund your inventory purchases. It's only gonna fund the replacement of inventory sold. So best practice would be to allocate more than your COGS to this inventory account.

4:02

Now, one of the challenges here is you may grow to a point where you cannot allocate enough to buy inventory. Debt funding is the primary method by which ecommerce businesses fund the purchase of inventory in these cases. Profit First discourages using debt. I'm a bit more pragmatic in that using debt can be good if used wisely.

The challenge is a lot of businesses don't understand the cost of debt and their implications on profitability. Revenue loans from Shopify, Amazon, and others are very expensive, so businesses need to tread carefully. Banks don't like to lend to a consumer products company, so you have to be really smart about your debt strategy.

Again, Profit First's answer is to not use debt and to fund your business growth with cash. Easier said than done. My recommendation is to use good accounting to make good decisions, but LedgerGurus is an outsourced accounting firm, so I might be a little bit biased.

4:40 Where Profit First stops

Other dedicated accounts could include an account for fulfillment, an account for marketing, account for technology spend. It is really easy to go crazy with accounts. You gotta be careful, and the reality is you still need to understand the full picture of your business.

Profit First gives a cash management method, but it doesn't really measure profitability. That's best done with accounting and good financial reports. Along with those, I would highly recommend a budget and a cash flow forecast. A budget will help you understand if your CAPs are reasonable. What I found with cash flow forecasting is where you need to add debt to supplement your allocations for inventory purchases.

5:11 What changed my mind and my own story

I was a skeptic of Profit First until I read the book. I thought those were people who weren't serious about understanding their financials. But what I've realized is there's value in special purpose accounts. I've actually used them for years. When you combine the practices of Profit First with good accounting, budgeting, and cash flow management, you are primed for excellent financial execution.

All that said, the key is to figure out how to operate within constraints. Some ecommerce businesses have low gross margins. Many have inefficient marketing spend. Others have fulfillment challenges due to the size or weight of their products. This is where the work happens, figuring out how to optimize your spending.

5:43

Now, here's my personal story. A few years ago, I bought an ecommerce business, Sole Toscana, with a few partners. One of the partners ran the business, and we burned a lot of money in the first year trying to get our marketing optimized. We read Profit First and got on board with this methodology. We stripped out all the wasteful spend on marketing, and my operating partner got really serious about making marketing more efficient. It wasn't easy, but we went from losing money to being able to pay the operating partner and generate a profit.

I'll say it one more time. Profit First is a mindset as much as a practice.

If you'd like to learn how your ecommerce business can become more profitable through Profit First, through good accounting, budgeting, or forecasting, reach out to LedgerGurus where we can help you. And if you found this video helpful, like it, share it, ask me a question in the comments, and subscribe to our channel for more content like this.