How does the average solo and small firm partner think about the profit their firm produces each year? In very simple terms, their mental equation probably looks something like this:
Revenue – Expenses = Profit
This is the traditional and very rational view of how profit is produced. And the traditional result is that profit is incidental. Basically, what’s surplus after the bills are paid.
But, according to the book Profit First: A Simple System to Transform Any Business from a Cash-Eating Monster to a Money-Making Machine by former Wall Street Journal columnist Mike Machalowicz, the right equation should look something like this:
Revenue – Profit = Expenses
This new approach turns the traditional “profit is what’s leftover after overhead and expenses are paid” method on its head. According to Machalowicz, a much more proactive approach is needed to guarantee that a profit will be there at the end of the year. He advocates that when revenues come in a portion is immediately set aside for profit and the rest covers overhead and expenses.
To do this successfully means profit is budgeted for in advance. How is that done? We believe you do this by looking at the last several years of gross revenues and profit percentages to forecast what the coming year’s profit will be. Unless you’re in a practice area that’s more volatile or subject to marketplace or legislative factors that are imminent. If you believe your firm’s history is a reliable indicator of its future, then set a profit goal that’s at least 10% to 20% higher than last year. Then divide that figure by twelve to establish a monthly goal.
Following that exercise, set up a systematic way of paying into the profit account monthly. When new revenues come in, a percentage is immediately swept into a separate profit account. What’s left is used to cover expenses.
Some proponents of this theory take the conservative approach of underpaying these accounts on a monthly basis and then make up the difference at the end of the year. Others do what it takes to deposit the full amount each month, then resist the urge to dip into the account when they experience a shortfall in other areas.
If you believe you’ll have to adopt a more rigorous focus on expenses to achieve this end, you’d be right. But given the painful experience of working for years and never having much of a profit, it’s well worth the effort.
In all cases, for those who adopt this proactive approach, profit is not the last thing that’s considered, it’s the first. Not surprisingly, the more intentional you become about profitability, the more likely you are to produce it.