There are different approaches to managing your finances and ensuring your business is successful. Profit First accounting is a relatively new approach to managing finances, while traditional accounting has been used for centuries. Understanding the differences and how these two systems complement each other is essential to maximise both the performance and profitability of your business.
Understanding Profit First Accounting
Profit First Accounting (PFA) is an innovative approach to business accounting. Where traditional accounting focuses on income and expenses, PFA shifts the focus to profitability. Profit First Accounting looks at cash-in/cash-out transactions only, providing an accurate assessment of the business’s cash flow.
The main focus of PFA is to help businesses become more profitable and create more sustainable growth. This type of accounting can also help businesses to become more efficient by creating a plan to prioritise profits over all other expenses. PFA is a great way to keep track of your business finances and ensure that your business is maximising its profits.
Benefits of Profit First Accounting
- Profit First Accounting helps you to prioritise profit in your business, rather than just focusing on the revenue and expenses. This system helps businesses become more profitable by encouraging them to put a percentage of their revenue into a separate, designated profit account. This account rewards the business owner for having a business by providing a quarterly distribution.
- Furthermore, Profit First helps businesses understand where their money is going, and how it is being used by directing the income to special-purpose bank accounts.
- It also allows businesses to stay on top of their finances, and ensure that their money is being used wisely.
- Profit First Accounting helps businesses build a reserve of funds for unexpected expenses or downturns in business.
Traditional Accounting
Traditional accounting is the method of bookkeeping and financial record-keeping that is used by most businesses. It is used for determining the taxable income of a business in which the focus is to maximise the number of deductions the business claims to lower its tax. It is also used to track all transactions and to accurately measure the financial performance of your business to provide financial statements showing the business’ profitability or liquidity. These financial statements are especially important when raising capital, either through business loans or investors.
Traditional accounting also includes the use of standard accounting principles such as the matching principle, the accrual principle, and the cost principle. These principles help to ensure that your financial statements are accurate and up to date. Using the traditional accounting method helps you determine the areas your business is profitable in and to identify areas that need improvement.
Benefits of Traditional Accounting
- Maximise business expenses to minimise tax.
- It provides a business with financial records to raise capital for the business.
- Traditional accounting is an effective way to identify potential problems and opportunities for improvement.
Which System is Best?
There is a place for both is your business: Profit First Accounting concentrates on the profitability of your business in particular where the money (cash) coming in is going, but traditional accounting keeps an accurate account of the business’ income expenses to provide the accurate financial information for tax records/compliance, raising capital and identifying where the potentials problems are and areas for improvement.
In short, Profit First is a way to manage finances through the behaviour of the business owner, whereas the traditional accounting method is still required for reporting and measuring the performance of a business.
Additional Business Concepts is here to guide you through these accounting methods, to grow a profitable business and bring financial freedom to your personal finances. Get in touch today.
Related Posts: