Ep #9 Profit First Chapter 5 – Allocation Percentages

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Hello and thank you for joining us today on the Profit Scale Thrive Podcast, where we guide attorneys to overflowing profits, scaled growth, and thriving lives. I am your host, Kelley Brubaker.

We have a secret though - this is a special place because we don't work with every law firm owner, we support the solo attorneys who are single parents because we know the special challenges you face, and we know the business advice out there is not always practical for you and your firm.

Each week we will talk about things that will give you the insight you need to stop feeling overwhelmed, to gain back your confidence, and to finally enjoy your law firm and your life again.

Podcast Episode #9: Profit First Chapter 5 – Allocation Percentages

Hello and thanks for joining me today for podcast episode number nine. 

Welcome back, or for those who don't know me yet, my name is Kelley Brubaker. I'm a CPA and a business coach who supports solo attorneys who are single parents. 

I'm also a certified Profit First Professional, which means I help my clients implement the cash management system presented in the book Profit First written by Mike Michalowicz.

A few weeks ago starting with episode 5 of my podcast, I began a dedicated series of podcasts to share with you in detail chapter by chapter of the book Profit First. So if you have read the book, please follow along as I will share tips not in the book along the way. If you have not read the book, but you are curious about it, please stick around as we go through chapter by chapter.

This week we are talking about Chapter 5 – Allocation Percentages. This chapter is the last of our prep work to get ready to put Profit First into motion. Last week we prepared our Profit Assessment to show us how we’ve been using our money (our CAPs or current allocation percentages) and where we could be using Profit First (our TAPs or targe allocation percentages). This chapter digs into what all of these percentages mean and how to customize them for your business.

Mike starts this chapter with a story about an unnamed colleague of his. As an up-and-coming motivational speaker, she attended a speaking bootcamp.  The instructor taught his sales method and exclaimed that if the attendees follow his sales method, they should expect 80% of each audience they speak to will buy the speaker’s product by the end of the event.

Mike’s colleague starts booking speaking engagements. She was disappointed to only close 25% of her audiences at first. So far away from the 80% target, but she pushed through refining her sales strategy and pitch where over a few years she finally attained 75%.

She ran into the instructor one day and asked for guidance on how to close the gap from 75% to 80%. The instructor’s jaw dropped – his response, “80%? You thought I said 80%? I said 18%!”

Powerful illustration right there!  No matter what the number is, if you work toward and believe it’s possible, you will not only achieve it, you will blow past it.

Two Common Problems

So, I’m sure you noticed last week with our Instant Assessments that the target percentages were provided in ranges based on real revenue. Let me emphasize that they are suggestions for running an efficient and well-run business.  The target percentages are not set in stone though!  But here are two common problems people encounter with Profit First.

1. Don’t get bogged down in the details. Some business owners get caught up in the details of the numbers or so stuck in the minutiae that they never actually get started – analysis paralysis. I know I’m guilty. My coach and peers tell me every now and then that done is better than perfect.
   
   
2. Look before you leap. On the opposite side of things, there are some business owners who decide to jump off a cliff and build their parachute on the way down. Not being adequately prepared can set you up for failure. I love Mike’s analogy: going full throttle into Profit First on day one is like donating 5 gallons of blood…your body has less than 2 gallons of blood. Instant death. To reach a goal of donating 5 gallons of blood, donate pints at a time and over time, you will eventually reach your goal of 5 gallons – cumulatively.

So – I ask you to accept that the TAPs, target allocation percentages, from the book are targets, future goals. Not to start with today. On the other hand, if you think you will never reach the TAPs, Henry Ford would say, “If you think you can or think you can’t, you’re right.” Be optimistic. Think you can and you will.

If you are one of the few companies who are performing better than the TAPs, congrats! Don’t slow down!! 

Current Allocation Percentages (CAPs)

Your CAPs from the Instant Assessment are where you are today. This is the number that you will slowly and deliberately adjust each quarter over time to reach your TAPs. 

Some of you listening may say, I’m a “go big or go home” type of person. Ok. But, if you hoard most of the food at the dinner table for yourself, you are not going to have any fuel for your business.

The key to implementing Profit First is to string together a series of small steps into a repeating pattern. Remember, the erratic, noisy rhythm that you have been using to manage your cash caused you confusion and panic. By the end of the next chapter, we will get you into a simple rhythm that will give you clarity and control over your money.

Your Profit Target Allocation Percentage (Profit TAP)

Remember your TAP from your Instant Assessment last week for Profit? Mike offers some considerations to adjust this to a more meaningful number.

1. Research public companies. This will be tough for law firms, but if you are in a different industry, this could be possible. Spend time on the internet searching for leading public companies in your industry. Compute the 3-5 year average for profit by taking the net income divided by the total revenue and use this as your TAP.
2. Review your business tax returns for the last 3-5 years. Determine your most profitable year, again using the net income divided by the total revenue. Using a percentage for this comparison is important because a billion-dollar company that only had one million in profit is less desirable than a million dollar business that had $750,000 in profit.  Percentages matter here.
3. Or, the easiest way, use the TAP based on your projected annual revenue for this year.  

Many companies never reach their TAP. That’s ok. It’s a goal to reach for. What matters is improving over time, day over day, month over month and year over year.  Keep in mind that your profit account is part of your income as a business owner and it will serve as your rainy-day fund.  As a rule of thumb, 5% will equal 3 weeks of operating cash, 12% will equal 2 months and 24% will equal 5 months.  I know the math seems off with the percentage doubling and the benefit tripling, but the bigger your profit allocation, the leaner your business is. It will need less operating cash.

Owner’s Comp TAP

No longer are we paying everyone else but you! No more leaning on credit cards or borrowing from friends and family. Your business exists to serve you! You deserve better than the leftovers.

Owner’s compensation is the money dedicated to paying you and any other business owners for the work you do for the company. Any owners who do not work for the business are NOT included here. They would only receive profit distributions. This is your salary.

If you want to adjust this TAP, Mike suggests:

1. At a minimum, this should equal what you would pay an employee dedicated to perform at least 80% of the work you do for the business (should you no longer work day-to-day for the business).  Consider also if there is more than one owner working in the business. Allocate enough here to adequately compensate the owners!
2. Use the TAP based on your projected annual revenue for this year.  

If you have more than one owner, please ask your tax preparer if there are any IRS regulations on how salaries can be divided amongst owners. S-Corps have different rules than LLCs, partnerships and C-Corps.

Don’t Underpay Your Most Important Employee

Mike has a warning for business owners who are not adequately compensated. Many business owners grow enough to hire staff to get them out of the day-to-day grind and free up their time to work on the business to grow it. But, without systems in place, many owners end up spending their day guiding employees and answering their questions which leaves them no time to grow the business. This also leaves little money to pay a fair salary to the owner.

The transition from being a one-person operation to a two person operation is wonderful but as you add more employees, if you do not have systems and processes in place and documented, it will be to your detriment in the end.

You deserve better than “bottom of the bowl”. You can’t and should not live on minimum wage or less. Say it with me: my business serves me; I do not serve my business. Don’t cut your salary to make the numbers work. The goal of every business is health which is achieved through efficiency.

Your Tax TAP

Let’s revisit a comment I made a few chapters ago – Profit First is NOT an accounting system. It is NOT about tracking every penny. That is work for your bookkeeper. Profit First is about how to handle your money quickly and easily with numbers that are fairly accurate. 

The tax TAP is an important one! This is designed to pay for all taxes of the business and the personal taxes of its owners.

You started your business in part for financial freedom. Shouldn’t your business make sure your taxes are paid for? Hell to the yes!

Keep this simple and don’t over think it.  Any tax bill that is due, gets paid by the company.

Your tax TAP will need adjustment. Keep in mind that the 15% TAP is based on Real Revenue and not net taxable income (how your tax forms compute tax due). Here are a few ways to adjust this TAP:

1. Look at all of your business and personal tax returns for the last 3 years. For each year, add up total tax owed (aka tax liability) – this is NOT the balance owed with the return. Divide the tax owed by the Real Revenue for that year. Determine your TAP based on what you discover here.
2. Ask your tax preparer how much he/she projects you will owe this year for both the business and personally. Divide this total by your projected Real Revenue. This is your new TAP.
3. You can use 35% for US-based business which is the starting corporate tax rate or the prevailing rate for your country. This will most likely be a bit high of a percentage but at least you will not be scraping for money to pay your tax bill next April.

Mike offers up some simple math on how he came up with 15% for the tax TAP. But, it’s a lot of numbers that I think will leave you cross-eyed if I read them aloud to you.  I’ll just say that I rarely see clients using 15%.  Many are lower, some higher.  The goal here is to save at least as much as you will owe for this year. If you save too much, it becomes a bonus or pads your tax account for next year! Winning!

The one thing not mentioned in this chapter is that if you do change your TAPs, be sure they all add up to 100%!  Not sure where to put any unallocated money? I prefer to put it in my profit TAP, but you can put any unallocated money where you feel it would be best put to use.

Listener’s Question of the Week

And now, it’s time for our Listener’s Question of the Week!

Same as the last few weeks, instead of a listener’s question today, there is a side note in chapter 5 of Profit First that is something I would like to address here.

From Mike on pages 80-81 of the book:

The goal is to make your profit allocation percentage as high as possible. However, super high profit percentages are not sustainable. At least not for long, and definitely not if your revenue stays stagnant. The reason for this is that if you can pull off consistently fat profits - say 50% allocated to profit and only 10% of revenue to your operating expenses - your competitors will figure out what you're doing. Then to get more business, they will drop prices (they likely have the profit margins to afford it). When that happens, you will have to drop prices to in order to stay in business. For competitive sharks, fat margins can be like blood in the water. The only way to keep big margins is to milk them for all their worth when you have them, and keep innovating to find new ways to bump up profitability.

If you would like to submit a question for a future episode, please send an email to [email protected] – and no - by sending an email you will not get added to an email distribution list, there will not be a phone call and there will not be a sales pitch. We follow the golden rule – treat others how you wish to be treated!

Inspirational Quote

This week’s inspirational quote is from Henry Ford – “Obstacles are those frightful things you see when you take your eyes off your goal.”

Final Thoughts

Final thoughts for today! I hope you are enjoying this approach to the book Profit First! Today we talked about how TAPs are not set in stone. They are provided in the book as a goal based on research Mike conducted of healthy businesses. But, there are times when you should deviate from the TAPs provided for in the book. We talked about alternative ways to customize your TAPs.

Here are your action steps for this week: 

1. Based on what we talked about today, customize your TAPs. Remember TAPs are the “X” on your roadmap. They are not our starting point.
   
   
2. Because you customized your TAPs, you will need to update your Instant Assessment to reflect your new TAPs.
   
   
3. Based on your CAPs, where you currently are, determine your current allocation percentages by decreasing your OPEX by 3% and increasing your Profit, Owner’s Comp and Tax allocations by 1% each. Remember your total allocations should add up to 100%. Begin making your allocations of current deposits this week. Mike suggests making allocations on the 10th and 25th of each month. I make mine every Monday because that works better for me. See what works for you.  Plan to make at least 2 allocations per month.  Find your rhythm.

Next week, we will be putting Profit First into motion. 

Please don’t be discouraged or overwhelmed at this point! What you are feeling is normal – totally and completely 100% normal.

If you need to pause here before moving to the next chapter, ok - but please set up your profit account and allocate 1% of your income each week.  I know how this seems so small and pointless, but I promise there will be a noticeable impact on you and your business while you gain the benefit of creating a positive habit by the time you return to the book.

If you have any questions about today’s episode, feel free to comment if you are watching on YouTube or send me an email to [email protected].

If you know someone who might need to hear this information, please share this episode with them or if you are on YouTube, tag them below! 

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Did you enjoy this episode? Please consider leaving a review. 

And before I go – remember - profit is something you intentionally plan for in the beginning. It is not a potential bonus at the end of the year!

Thanks, and have an amazing day!

If you have not read the book “Profit First” written by Mike Michalowicz, today is your lucky day! This episode is the 5th installment of a series that dives into the book chapter by chapter.

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