Profit is more than just a scoreboard for your business. It’s the fuel that keeps your enterprise running.
So, what happens after you make a profit? That’s where effective allocation comes into play.
It’s not just about making money; it’s about wisely directing money to sustain and grow your business.
Managing profits is no walk in the park, especially for small and medium-sized businesses.
You might be dealing with fluctuating revenues one month and unexpected overheads the next.
These challenges can make it tricky to maintain a stable profit margin and allocate those profits effectively.
Given these hurdles, you might wonder, “How can I manage my profits more effectively?” That’s precisely what this blog aims to address. So, if you want to get a grip on your finances, you’re in the right place.
Why is Profit Crucial for Sustainability?
Let’s start with a fundamental truth: no profit, no business. It’s as simple as that.
Profit is the cornerstone that holds your business together.
It allows you to pay your employees, keep the lights on, and invest in new opportunities.
Now, you might be thinking, “I get it, profit is important, but what’s the big deal about allocation?”
Profit is one thing; knowing what to do with it is another.
Strategic allocation ensures that your profit is put to work in ways that foster growth and sustainability.
Risks of Poor Profit Management
So, what happens if you need to manage your profits better? The short answer: nothing good.
Poor profit management can lead to cash flow issues, making it challenging to cover operational costs.
It can also result in missed opportunities for investment, hindering your business’s potential growth.
And let’s not forget about the stress and anxiety of financial instability. When constantly worrying about making ends meet, focusing on long-term strategies takes a lot of work.
In the worst-case scenario, poor profit management could even lead to the downfall of your business. The linchpin can either propel your business forward or hold it back.
That’s why understanding how to allocate your profits strategically is essential for the long-term health of your business.
Understanding the Profit First Model
You might have heard of the Profit First Model by Mike Michalowicz. If not, let me give you a quick rundown.
It’s a financial management approach that flips the traditional formula. Instead of focusing on revenue and expenses first, Profit First prioritises profit.
It’s a game-changing perspective that can revolutionise how you manage your business finances. By putting profit at the forefront, you’re setting your business up for long-term success.
Target Allocation Percentages (TAPs) and Their Role
Now, let’s talk about Target Allocation Percentages, or TAPs for short.
These are predetermined percentages of your revenue that you allocate to different accounts.
Think of them as financial guardrails that keep your business on the path to profitability.
TAPs are the backbone of the Profit First Model. They provide a structured way to manage your finances, ensuring you’re not just making money but keeping it.
By following these percentages, you’re creating a roadmap for financial success.
Setting Up Bank Accounts for Profit Allocation
Profit Account: Your Starting Point
If your business is relatively straightforward, with minimal subcontractor involvement or material costs, your Profit Account should be your first port of call. Aim to channel between 5-10% of your total revenue here. Consider this account your financial cushion, ensuring your business stays in the black.
Special Considerations for Complex Businesses
Now, things are different if you’re running a more intricate business, like a trade-related enterprise with subcontractors and significant material costs.
In such cases, you must allocate funds for Goods and Services Tax (GST) and materials before anything else. This ensures you’re covering your bases and staying compliant.
Owner’s Pay: Your Fair Share
Once the Profit Account is sorted, turn your attention to the Owner’s Pay Account. Here, you should aim to allocate at least half of your revenue. After all, you’ve put in the hard work, and it’s only fair you get compensated accordingly.
Tax Account: Planning Ahead
Next up is the Tax Account. A good rule of thumb is to allocate 15-20% of your revenue here. This proactive approach ensures you’re aware when tax season rolls around.
GST Account: For Eligible Businesses
If your business rakes in more than $75,000, you’ll need a GST Account. Plan to allocate 10% of your revenue here. Remember, this allocation should be done before any other calculations if you’re in a complex business model.
Operating Expenses (Opex) Account: Keeping the Lights On
Finally, whatever revenue remains should go into your Operating Expenses (Opex) Account. This account handles the day-to-day running costs, from utilities to marketing.
It’s worth noting that these percentages are not set in stone. They’re starting points, and you may need to tweak them based on your business needs. The key is to start with these guidelines and adjust as you go along, ensuring your allocations align with your business goals.
Following this structured approach to setting up your bank accounts for profit allocation, you’re laying a solid foundation for financial stability and growth.
Step-by-Step Guide to Implementing Profit First
Step 1: Understand Your Business Model
First, you’ve got to get to grips with your business model.
Understanding your revenue streams and cost structure is crucial.
It’s the foundation upon which you’ll build your profit allocation strategy.
Step 2: Analyse Your Financials
Once you’ve got a clear picture of your business model, it’s time to dive into the numbers.
You’ll want to carefully review your income statements, balance sheets, and cash flow.
This financial health check will inform your allocation decisions.
Step 3: Determine Your Target Allocation Percentages (TAPs)
You can set your Target Allocation Percentages, or TAPs, with your financial insights.
These percentages are your financial roadmap, guiding you on how to allocate your revenue.
Remember, these are just guidelines; feel free to adjust them to suit your business needs better.
Step 4: Monitor and Adjust
Setting your TAPs isn’t a set-it-and-forget-it deal.
You’ll need to review and adjust these percentages regularly.
Regular check-ins ensure that your allocations are still serving your business goals effectively.
Common Pitfalls and How to Avoid Them
Limited Profit Allocation
One common pitfall is to allocate more to your Profit Account.
This can stifle your business’s growth potential.
Ensure you set aside a sufficient percentage to keep your business running and thriving.
Insufficient Owner’s Pay
Another mistake is underestimating the Owner’s Pay Account.
You’re the driving force behind your business, and you deserve to be compensated accordingly.
Don’t shortchange yourself; allocate a fair percentage to your Owner’s Pay Account.
Neglecting to allocate enough for taxes is a recipe for trouble.
The last thing you want is to be hit with a hefty tax you were surprised to receive.
Be proactive and allocate a sensible percentage to your Tax Account.
Overdue Operating Expenses
Finally, failing to allocate enough to cover operating expenses can lead to operational hiccups.
You want to be able to pay for essential services or supplies.
Ensure your Operating Expenses (Opex) Account is adequately funded to keep your business running smoothly.
Following this step-by-step guide and steering clear of these common pitfalls, you’re setting your business up for financial stability and growth. It’s all about being strategic and staying vigilant.
Additional Business Concepts Is Here to Assist!
We at Additional Business Concepts are here to guide you. Contact us today for personalised advice on how Profit First can transform your business.
You’re laying the groundwork for a financially stable future by taking action now. We look forward to partnering with you on this journey.