162 – Mike Michalowicz

162 – Mike Michalowicz

How to transform any business from a cash – eating monster to a money-making machine.  In this episode you will hear Mike Michalowics Author of profit first compare four lessons from the healthy diet industry to the four core business diet lessons of Profit First.

We will start with Mike describing The Frankenstein Formula

  • One day I had the realization that I am Dr. Frankenstein.  I too can take and idea and bring it to life, and then quickly come to realize I have created a monster.  A cash eating monster.
  • The only way to survive is to sell more and more. Growth seems to be the only solution. But as the business gets bigger, so does the stress. The bigger the business, the more cash it consumes.
  • It seems, to really be profitable, we need that one big client, or one big sale, or one investor to swoop in and save us.
  • Most entrepreneur's companies survive check to check. Profit seems to be so elusive, because every time sales increase, expenses increase at the same rate.
  • The problem is not the entrepreneur, it’s the profit formula we all have been told to use: Sales - Expenses = Profit

Does this resonate with YOU?  Next is Mike describing why GAAP doesn’t work.

  • The core formula to GAAP {Generally Accepted Accounting Principles) is Sales - Expense Profit.  It logically makes sense, but it ignores that fact the humans are behaviourally oriented not logically oriented.
  • Few entrepreneurs are diligently managing their financials using GAAP. It requires that the entrepreneur understand and manage their business by regularly analysing their Income Statement, Cash Flow Statement and Balance Sheet. It requires that those reports are analysed regularly, minimally once a month, ideally more frequently…But entrepreneurs don’t do it, as "logical” as It is, but we do have another habi..  we look at our bank balances constantly.
  • Most entrepreneurs manage the financial aspect of their business using "bank balance accounting." We look at our bank balance and make a determination of how healthy our business is based on the balance. A big bank balance and we feel confident. A low balance and we go into panic mode to sell like mad and collect money any way we can.

Is this sounding familiar?  How many of you check your bank balance first thing every morning?   I asked that question to 35 accelerator students and three quarters of them check it every day sometimes twice a day.

Mike explains… Don’t change your habit (you can’t) change the structure around you.

  • Changing our own habits is hard (some would argue impossible). Just ask a smoker.  Logically it is one of the most life-threatening routines we can have. Yet the habit  Often the only way to change a habit is because of a catastrophic event (for the smoker it could be a heart attack or stroke).  Otherwise the habit continues.
  • But habits can also be channeled and directed, making that formally "bad habit" your biggest ally.
  • Instead of stopping your habit of "bank balance accounting" (checking your bank account regularly and making financial decisions based upon what we see) the process of Profit First leverages it and makes it your biggest ally.

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Here’s Mikes explanation of the core four lessons from the healthy diet industry and how it compares to the four core business lessons from profit first.

  • USE SMALL PLATES - The normal habit of people is to serve food that fills up their plate and then to eat everything on the plate. So instead of trying to change the "fill up the plate and eat it all" habit, simply reduce the size of your plates and continue your habit. A smaller plate will automatically leverage our established habit, and reduce our calorie Intake. We lose- weight.
  • EAT VEGETABLES FIRST - Most people eat the meat and potatoes first. The vegetables are put aside to "eat last." But the person eats all the meat and potatoes first and then, feeling full, doesn’t eat the vegetables. Yet, if we simply ate a serving of vegetables first, we would get all the vitamins and nutrients while also filling up our stomachs so that we don’t gorge on the meat and potatoes.
  • REMOVE TEMPTATION - You won’t eat desert If it’s not available to eat. But that desert tray waved in front of you makes It so easy to have it "just this one time." To avoid eating junk food, the best strategy Is to not have access to it in the first place. As they say, out of sight out of mind.
  • ESTABLISH AN EATING RHYTHM - Most people eat either too infrequently or too frequently.

The folks who eat too infrequently often plan to eat three meals a day (breakfast, lunch and dinner), and will occasionally skip one of the meals when they are in a rush. The result is that they feel intense hunger and then overeat during the next meal. Other people are the constant snackers.  Food is always in arms reach and they snack any time the food is present.  In either case, to person consumes to many calories and puts on more and more weight

The core four business diet lessons of profit first:

1. USE SMALL PLATES

  • Most business owners have only few accounts (big plates) for their business. They have an operating account where deposits come in and payments go out. They may have an employee payroll account and a savings account. But regardless of what accounts they do have, typically the majority of money flows in and out of a single, big plate, operating account.
  • Since entrepreneurs do bank balance accounting (we look at how much money is available in the account and take actions based on what we see), we need to allocate money into different accounts (small plates) which specify how the money can be used.
  • This is grandma’s old envelope system. Grandma would get $100 and divide that money up into different envelopes for different purposes. The $100 would come in, and immediately get divided up: 1. $10 for vacation 2. $35 for groceries 3. $15 for clothing 4. $25 for home expenses 5. $10 to “give back” 6. and $5 for “fun money".
  • Grandma would always have enough money for every aspect of life ... she would just go to the right envelope. And If the money wasn’t there, It didn’t mean there wasn't enough money, it meant it wasn’t time to spend it yet.
  • In our business we need to have small plates too.  Minimally we should have 4 small plates and 1 serving tray.  The small pates are 1.  Profit Account 2. Owner’s Pay Account 3. Tax Account 4. Operating Expenses Account. And the serving tray Is the Income Account.
  • All inbound money goes to the Income Account. This account is only for accumulating deposits. Then the money that has accumulated in the Income Account is periodically allocated to the "small plate accounts" based upon predetermined percentages. A percentage of all the money in the Income Account goes to the Profit Account, then a percentage to Owner’s Pay, etc.
  • TARGET ALLOCATION PERCENTAGES (TAPS)  - Based upon your businesses Real Revenue (this is your company's total  income  minus material  costs  and outside  labor - similar to, but not the same as Gross  Profit),  your company  should target  allocating  a certain  percentage of the Income Account to the different  small plate  accounts.  Go to http://MjkeMjchalowjcz,com/

Resources to  download a chart  with the TAPs  percentages.

  • TAPs  is a target  allocation  percentage and not the starting  point percentages for your  business. The TAPs  are for very healthy companies,  and just jumping to those  percentages can be far  to fast  of an adjustment for  your company.  Instead  start  at a smaller percentage (perhaps  start allocating  only 5% or 1 % of your Income Account) to Profit and other accounts,  and every quarter increase  that  percentage.

2. EAT VEGETABLES FIRST

  • As you start allocating  money to different accounts,  many businesses  will find that the amount of money  available for  Operating Expenses  is 60%, 50%, 40% or even less of the total Income Deposits that  is available.
  • The entrepreneur, in this circumstance, will feel extreme pressure  to reduce  costs and expenses (this Is what  you want to do),  but feel that  it may be best to "borrow" from the Profit, Tax  or Owner's  Pay account... in other  words,  to skip eating the vegetables.
  • When there Isn't enough money in your Operating  Expenses  Account to cover your bills, you may NOT "borrow" from  your other  accounts.  Instead, this is your business  telling you (better said, screaming at you) that  you cannot  afford  your expenses.  You must become  more Innovative. You must cut  costs and find  ways to get the sames things done at less cost. And  you must extract all the value out of your expenses

3. REMOVE TEMPTATION

  • The quick (and tasty) fix to  not  having enough  money to  pay expenses  it to take the money from our tax account,  profit account or owner's pay account.  If the money in these accounts remains at the same bank as where  you have your Operating  Expenses, it is too tempting and easy to transfer the money.
  • Setup a Profit Account,  Tax Account (and even the Owner's  Pay account if you find yourself "borrowing" from the account to pay expenses)  at a second  bank. Then when you do your percentage allocations  from the  Income Account, and move  the money Into these "small  plate" accounts, next transfer all the funds from the Profit Account and Tax Account to accumulate at the second  bank. Take steps to  make sure that  you don't  have easy/convenient access  to the second  bank ... you just  want to accumulate the Profit and Tax money  here and then  disburse  it on a quarterly  basis (explained  in the Eating  Frequency  section).
  • Destroy your credit cards,  which  is another  massive  source of temptation and replace  them  with debit  cards.

4. ESTABLISH AN EATING FREQUENCY

  • Most business  owners manage their money  to frequently (they  pay  bills and themselves sporadically, whenever they feel they have enough  money)  or too  infrequently  (they  wait  until they are in a panic and need money, or a vendor has started  collections).  Instead  you need to get  into a 10/25 Rhythm
  • The 10/25 Rhythm has us disbursing money two  times a month, on the 10th (or the nearest business  day) and the 25th (or the nearest  business  day).
  • The 10/15 Rhythm allows  money  to accumulate in the Income Account  over  a few  weeks time. You still  make deposits every day (or as frequently as money comes  in), but it simply accumulates Into the Income Account. By allowing money  to accumulate,  our habit of  Bank Balance Accounting will give us a keen awareness of the natural  cash flow  of our business. We see money  accumulate for two  weeks, it then gel's  allocated completely.  Then it accumulates over  the next  two weeks  and then  allocated  completely. This pattern continues  Into perpetuity, and we get a keen understanding of our cash flow.
  • On the 10th all the money In the Income Account  gets  allocated  to the different small plates accounts, based upon the percentages you have predetermined  (ultimately  moving closer  and closer to the TAPs).
  • Then on the 10th, the money allocated to the Profit and Tax accounts,  gets  immediately transferred to the "temptation removed" accounts at the second  bank. On this day, all the bills that  are due are paid from Operating Expense. As shared before, if there  is not  enough money In the Operating Expenses  account,  this it the business  stating  it can't  afford the expenses and they  need to  be cut.

The same occurs  on the 25th - Allocate all funds  from  the Income Account,  remove temptation and pay expenses  from  the Operating Expenses account.

  • On a quarterly basis, from the Tax Account (at the direction of your accountant - note that you may want to consider a Profit First Professional,  an accountant, bookkeeper or other  financial expert  that  is certified  in Profit  First) you will pay your quarterly  tax estimates.
  • On a quarterly basis, your company will take a profit distribution. 50% of the money that has accumulated in the Profit Account will be taken as a profit distribution to the owners.
  • The profit distribution you take Is for  YOUR purposes.  Celebrate with  the money, use it for you ... don't use It to "plowback" into the business, since that defeats the entire  purpose  of Profit  First.

If you remember nothing else, remember this: Profit first, always.

Resources and Links Mentioned in this Session Include:

Graphics+ Charts from Profit First

Profit First One Sheet and Overview

Toilet Paper Entrepreneur

Profit First

The Pumpkin Plan

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