It is all about what you are trying to achieve.
With traditional accounting, the outcome is to collate the business’ financial statements to show its financial performance over a given period of time.
Profit & Loss Statement
Has the business made a profit or a loss?
Has the business improved its profitability this financial year compared to last financial year?
Balance Sheet
Is the business liquid, does it own more assets than it has liabilities?
How much in assets does it own?
How much in loans does it owe?
These numbers are important, they are necessary for knowing how much tax the business needs to pay or how much the business is worth to sell or to ask the bank for a loan.
These reports are what excite bookkeepers and accountants as we can look at them and know the financial viability of a business and in many cases where the business is struggling. However, most business owners have glazed over and look like a kangaroo staring into headlights when their bookkeeper and accountant present these reports to them and wonder why they have to pay taxes when there is no money left in their bank accounts.
The Profit First system is a cashflow system designed to help the business owner know by looking at their bank accounts what their cash position is at any time of the day or week. It is not an accounting system. It is a behavioural system.
By separating the income out into separate expense accounts (ie. Profit, Owner’s Pay, Tax, Operating Expenses) the business owner can see at a glance, how profitable the business is, if they can pay themselves, if they can pay their staff or purchase a piece of equipment.
The system works with behaviour in two ways:
- Reward: By putting separating the profit into a separate account (out of the way) the business owner knows they are working towards a goal that will reward them every quarter.
- Control: The business owner can see from the income account how much actual revenue is coming in and make decisions around that – if they need to reduce their expenses, call the customers who are overdue with payments, or change staff rosters.
Traditional accounting is a reporting system that lets you know the final results and the Profit First system keeps you tuned into how your finances are going as you manage the day-to-day.
The accounting system will tell you how much tax the company owes at the end of the year, but the Profit First system puts the tax aside based on the percentage of income each week/fortnight that money is moved from the income account to the different expense accounts.
The accounting system will tell you how much profit you made for a quarter/year based on income minus expenses, but the profit account will show you the actual profit you can keep and reward yourself with.
Did you know, the accounting profit does not reflect all your payments to your creditors?
- If it is calculated on an accrual basis and some of your customers have not paid you, it will be part of this “profit” you are then paying tax on.
- The accounting profit is used to pay any loans that your business is paying throughout the year, these transactions are on the balance sheet.
- Also, payments to yourself (the business owner) as a director or drawings not through payroll will come out of that accounting “profit” and you will then pay personal tax on that as well.
Traditional accounting is valuable and necessary, but if you have a Profit First Professional who has an understanding of accounting/bookkeeping in your industry they will help you set the system up tailor-made to your business and train you to work the system in your business.
Working with the Profit First system, you will be in charge of your day-to-day finances and that accounting meeting to look at the business’s financial performance will be so much more valuable as you will understand what the accountant is looking at and most likely be able to show them how your business is performing – in the cash in/cash out behaviour of your business’ finances. It may be the accountant will be the one gazing wide-eyed into the headlights.
Understanding both traditional accounting and the Profit First system can revolutionise how you manage and perceive your business finances. At Additional Business Concepts, we specialise in integrating these methods to give you a comprehensive view that enhances financial stability and performance. Contact us today to learn how we can tailor these systems to fit your specific business needs.
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