Mastering Profit First: The Five Essential Bank Accounts Every Small Business Needs

At it's core, business is about the pursuit of profit. All too often, though, profit seems to be an afterthought. Business owners are busy dealing with the day to day, firefighting all the urgent tasks, yet neglecting what's most important - making money.

Many entrepreneurs end up struggling to make ends meet. It's all too common.

We need to get strategic about our profit. The Profit First method, based on the book by Mike Michalowicz, is designed to help you to do just that.

Read the first two chapters of Profit First, FREE.

A Quick Introduction to Profit First

The Profit First method is a cash management method that flips the traditional accounting concept of profit. Unlike the conventional formula of "Sales - Expenses = Profit," Profit First prioritises profit from the start. It does this by guiding business owners to allocate income into different bank accounts, each serving a specific purpose. These accounts include Profit, Owner's Compensation, Taxes, Operating Expenses, and Income.

By implementing Profit First, businesses not only maintain consistent profitability but also get greater financial clarity, discipline, and stability.

So let's have a look at how using multiple accounts can help you, my business owning friend, get more profits in your pocket. 

Profit First and Parkinson's Law

Using multiple bank accounts is based on our understanding of how people behave, and applying Parkinson's Law to how we manage our finances.

Parkinson's Law says that "work expands to fill the time available for its completion." In terms of money, this means that if we have all our money in one account, it's too easy to spend it on different expenses and not have much left over for profit. Profit First solves this by separating our funds into different accounts for profit, owner's compensation, taxes, and operating expenses. By doing this, we take advantage of this psychological principle demonstrated by Parkinson.

Each account has a predetermined amount of money, based on our allocation percentages, which makes us prioritise and be disciplined with our spending. With clear allocations, profit becomes our top priority and we manage our expenses more efficiently. This helps us align our financial habits with our profit goals, and also ensures that profitability is the main focus on our financial journey. It's a powerful tool for increasing overall profitability and financial stability.

The Profit First Method: A Lifeline for Small Businesses Owners

By allocating your income into different bank accounts, you ensure that profit isn't just an afterthought; it becomes a non negotiable priority.

Setting up bank accounts is an important first step in the Profit First system because it offers a concrete and practical framework for financial success from the start. 

So let's take a look at the different accounts you need to set up Profit First. 

The Five Essential Bank Accounts You Need

There are five Profit First bank accounts that every business needs. 

1. Income Account

The Income Account is the gateway to financial clarity. It's the bank account where all your revenue flows in, giving you a bird's eye view of your cash inflow. You don't pay bills or anything else out of this account, it's simply here so you can collect income and then transfer funds from this account to all your other accounts based on your allocation percentages.

2. Profit Account

This one is the game changer! We transfer a percentage of all our income into this account, which gives us our profit. We do this first, which is why this method is called Profit First. To remove the temptation to dip into this account, we keep this account at a separate bank to our other accounts, and we make it hard for ourselves to access. 

3. Owner's Compensation Account

This account is where we transfer owner's pay. As the business owner, you need to be fairly compensated for your efforts. That's your reward for the work that you do for the business. 

Owner compensation covers salary provided to the owner as well as any expenses that the owner benefits from, like the costs associated with your personal vehicle, health insurance, etc. You can pay the owner straight out of this account, or you can transfer it back to the OPEX account if it's faster to pay everything out of that account, for example if you pay salaries as a payroll run.

4. Tax Account

We use this account to make sure that we have enough to cover taxes on business profits when they're due. If you also have to pay sales tax and payroll tax, we recommend setting up a separate account that is specifically for those taxes. The tax account is another account that you should keep at a separate bank, in a hard-to-access account to help you avoid temptation. 

5. Operating Expenses Account (OPEX)

This is the account that you use to pay all of your bills and business expenses - wages, rent, utilities, and all the other admin costs that you need to cover.

This is the last account that you allocate money to. The reason that this is the last, is so that you have a structure that rewards you for your investment and risk (Profit), for your work in the business (Owner Comp), and covers your tax obligations (Tax). When you've accounted for all of those, and you can manage your expenses on what's left, then you will have a permanently profitable business. 

Other Business Bank Accounts You May Need 

To use the Profit First method, you'll need those five account. However, you may find that you want to open some extra accounts to give you even more clarity over where your money should be allocated to.

As a rule of thumb, if you spend over 20% of your income in one particular area, it's a good idea to open an extra account. Here are some examples:

• GST - in Australia, if your business income is over $75,000 you'll need to pay GST, so it's a good idea to keep it in a separate account, as it's not your money
• materials - common for retail businesses who need to buy stock in
• subcontractors - useful for trade or service businesses where the business uses subcontractors rather than employees to get the job done
• marketing - very handy if you spend big on marketing or advertising
• equipment - ideal for saving up for big purchases like a cafe refit, or perhaps a new machine to help increase efficiency

 Just remember only to open as many as you need for clarity. Too many bank accounts ends up being confusing, which defeats the purpose of separate bank accounts!

Implementing the Profit First System

Now that you know the 5 Profit First bank accounts, you need to take action and set up separate bank accounts for your business.

Grab our handy guide to the best free business bank accounts for Profit First Australia. Plus, you'll find a quick guide to advanced Profit First bank accounts to answer all your questions! 

Profit First isn't just a cash flow management system; it's a lifeline for small businesses seeking stability, profitability, and efficient resource allocation. By using the five essential bank accounts and following the Profit First principles, you can take control of your finances, increase profitability, and secure your business's future. Don't let profit remain a dream; make it a reality with Profit First.

Resources mentioned in this article: 

First two chapters of the Profit First book - FREE

Ultimate Guide to Profit First Bank Accounts

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