As a small business owner, you may have heard the phrase “revenue is vanity, profit is sanity.” Yet, many entrepreneurs find themselves trapped in a cycle of increasing sales without seeing a corresponding rise in profits. If this sounds like your situation, it’s worth familiarizing yourself with the concept of Profit First percentages and how they can help you approach financial management.

The Profit First Method is simple: instead of calculating profit as what’s left over after expenses, you allocate profit first, ensuring that you set aside a percentage of your revenue for profit before covering other expenses. We’ll walk you through how to determine those amounts based on your industry and business age, and how to use a North One Account to put your Profit First system into practice.

Understanding Profit First Basics

Before diving into the specifics of Profit First percentages, let’s go over the fundamental principles of the system. Traditional accounting formulas make profit an afterthought by calculating it as a byproduct of sales and expenses:

Sales – Expenses = Profit

The Profit First model flips this equation on its head by taking profit first:

Sales – Profit = Expenses

This formula leverages human psychology by employing what creator Mike Michalowicz calls “Bank Balance Accounting.” This principle acknowledges that most business owners make financial decisions based on their bank account balance rather than complex financial statements. 

Profit First works with, rather than against, this tendency, by setting up five foundational bank accounts to allocate and manage money. Those accounts should be labeled as follows:

  1. Income: Where all revenue is initially deposited
  2. Profit: A percentage set aside for business profit
  3. Owner’s Pay: Funds allocated for the owner’s salary
  4. Tax: Money reserved for taxes
  5. Operating Expenses: Funds for running the business day-to-day

How to Structure a Profit First Bank Account

Most business owners will have to open separate bank accounts to employ the Profit First method, but North One makes it easy with Envelopes. Rather than opening five new accounts, North One users can use the Envelopes feature to create five sub-accounts to keep their money organized. In fact, North One has a button that will automatically create all five sub-accounts for you.

Why create these artificial divisions? By distributing funds into separate accounts, you create artificial scarcity in your operating expenses account, naturally encouraging more prudent spending and creative problem-solving to run your business efficiently. The question ultimately becomes one of allocation. How much should you set aside in each account?

Why Profit First Percentages Matter

The success of the Profit First system hinges on allocating your revenue into different accounts using specific percentages. Here’s why how much you allocate matters as much as how you allocate it:

  • Ensuring profitability from day one: Assigning a percentage of your revenue to profit ensures that it’s more than just what’s left over after expenses. Even if the initial profit percentage is small, this move establishes profit as a priority in your financial strategy.
  • Aligning your finances with business goals: By thoughtfully setting these percentages, you create a financial roadmap that supports your broader business objectives. For example, if you’re aiming for rapid growth, you might allocate a higher percentage to operating expenses to fund expansion.
  • Creating a sustainable cash flow system: One of the biggest challenges for small businesses is managing cash flow. By allocating income to different accounts based on percentages, you’re less likely to overspend in one area at the expense of another, helping to prevent common cash flow crises.
  • Providing clear financial visibility: When you distribute your income according to set percentages, you gain immediate visibility into your business’s financial health. A quick glance at your account balances can tell you if you’re on track with profit goals, if you’re setting aside enough for taxes, or if your operating expenses are creeping up.
  • Encouraging financial discipline: Adhering to specific percentages forces you to live within your means as a business, spurring creativity and efficiency in how you operate. If your operating expense percentage is lower than you’re used to, you’ll be motivated to find ways to streamline operations or increase revenue to meet your needs.

Factors That Impact Your Profit First Percentages

The Profit First system generally suggests that business owners allocate 5-10% of revenue to profit accounts each quarter. Now, before you carve off half your revenue, keep in mind that this is an ideal benchmark—one that many small business owners need to work towards. 

To get a better picture of what your allocations will look like today (to profit and the other four accounts), take time to look at the governing factors for your business:

Industry Standards and Benchmarks

Different industries have varying profit margins, overhead costs, and financial structures. For example, a software company might have higher profit margins but lower operating costs compared to a manufacturing business. Research industry benchmarks to get a sense of typical financial ratios in your sector. This can provide a starting point for your Profit First percentages.

Business Size and Growth Stage

A startup will likely have different financial needs compared to an established business. Early-stage companies might need to allocate more to operating expenses to fuel growth, while mature businesses might be able to allocate higher percentages to profit. Consider your business’s current stage and future growth plans when setting your percentages.

Profit Margins and Pricing Strategy

Your profit margins directly impact how much you can allocate to different accounts. If you have high profit margins, you might be able to set aside a larger percentage for profit. Conversely, if your margins are thin, you’ll need to be more conservative with your profit allocation and perhaps look at ways to improve your pricing strategy.

Operating Expenses and Overhead Costs

The nature and extent of your operating expenses play a significant role in determining your percentages. Businesses with high fixed costs might need to allocate a larger percentage to operating expenses. Understanding your cost structure is crucial for setting realistic and sustainable Profit First percentages.

Debt and Other Financial Obligations

If your business has significant debt or other financial obligations, you may need to adjust your percentages to account for these. You might consider creating an additional account for debt repayment and allocating a specific percentage towards it.

Seasonality and Cash Flow Patterns

Some businesses experience significant seasonality or irregular cash flow. If this applies to your business, you’ll need to factor this into your percentage calculations. You might need to adjust your percentages during peak seasons to set aside more for leaner periods.

Owner’s Financial Needs

The owner’s pay percentage should reflect both the owner’s financial needs and the value they bring to the business. This can vary greatly depending on the owner’s lifestyle, other income sources, and level of involvement in the business.

Tax Obligations

Your tax obligations can vary depending on your business structure, location, and profitability. Ensure you set aside an appropriate percentage for taxes to avoid cash flow issues when tax payments are due.

Future Business Goals

Your long-term business goals should influence your Profit First percentages. If you’re saving for a major investment or expansion, you might need to adjust your percentages to accumulate funds for this purpose.

8 Steps to Determine Your Profit First Percentages

Ready to calculate your own Profit First percentages? Follow these eight steps to clearly delineate how to best allocate your money:

  1. Assess your current financial situation: Gather your financial statements from the past 12 months. Calculate your current allocation percentages by dividing each category (profit, owner’s pay, tax, operating expenses) by your total revenue. Compare these to industry benchmarks to see where you stand.
  2. Calculate your Real Revenue: Real Revenue is the amount left after subtracting materials and subcontractors from your top-line revenue. Use this formula: Total Revenue – Materials and Subcontractors = Real Revenue. This is the figure you’ll use to determine your Profit First percentages.
  3. Determine your Target Allocation Percentages (TAPs): TAPs are the ideal percentages you aim to achieve over time. Research industry standards for guidance, while considering your business goals and financial needs. Set realistic TAPs for each category: Profit, Owner’s Pay, Tax, and Operating Expenses.
  4. Start with the Profit First recommended percentages: For businesses with Real Revenue under $250,000, consider these suggested percentages: Profit: 5%, Owner’s Pay: 50%, Tax: 15%, Operating Expenses: 30%.
  5. Adjust percentages based on your business specifics: Consider the factors discussed in the previous section. Gradually adjust the recommended percentages to align with your business needs and goals. Remember, it’s okay to start small with your profit percentage and increase over time. With North One, you can create and edit these automatic allocations at any time, as often as you like.
  6. Calculate your Current Allocation Percentages (CAPs): CAPs are the percentages you’ll start with, based on your current financial situation. These should be a step between your current allocations and your TAPs. Be realistic – drastic changes can be difficult to implement immediately.
  7. Plan for gradual implementation: Set a timeline for moving from your CAPs to your TAPs. Plan to adjust your percentages quarterly or semi-annually. Each adjustment should move you closer to your TAPs.
  8. Test your percentages: Use your chosen percentages to allocate your next revenue deposit. Assess how this allocation feels—is it too tight? Too loose? Make small adjustments as needed, always keeping your TAPs in mind.

Remember, finding the right Profit First percentages is an iterative process. It may take some trial and error to find the perfect balance for your business. The key is to start implementing the system and adjust as you go.

Tips for Implementing Profit First Percentages

Once you’ve established working Profit First percentages for your business, you’ll need to test them. Consider these tips for putting them into practice effectively—and for continuously evaluating them as you grow your revenues over time:

  • Establish a rhythm for transfers and distributions: Choose a consistent schedule for moving money from your Income account to the other accounts, or simply have North One take care of the allocations as soon as you receive the money
  • Create a buffer in your Income account: During high-income periods, allocate as usual but leave some extra in the Income account. Rely on this buffer during leaner times.
  • Use Profit First for debt reduction, if necessary: If you have significant debt, consider adding a Debt account and allocating a percentage to it until the debt is paid off.
  • Automate where possible: Set up automatic transfers between accounts to ensure consistency and reduce the temptation to skip allocations.
  • Track your progress: Regularly review your accounts to ensure you’re sticking to your percentages and moving towards your Target Allocation Percentages (TAPs).
  • Resist the urge to “borrow” from other accounts: To maintain the integrity of the system, treat each account as if it belongs to someone else.

Implementation is often the hardest part of coordinating a Profit First approach. It may feel uncomfortable at first, especially if you’re used to operating differently. Stay committed to the process, and you’ll likely see improvements in your business’s financial health over time.

Adapting the Profit-First Approach for Financial Success

Implementing Profit First percentages in your small business is more than just a financial strategy—it’s a paradigm shift in how you approach your business finances. By prioritizing profit and strategically allocating your revenue, you’re setting the foundation for long-term financial health and sustainable growth.

Remember: the journey to financial health starts with a single step. Begin implementing Profit First percentages in your business today, even if you start small. Over time, you’ll develop a financial system that not only ensures profitability but also aligns with your business goals and values. By prioritizing profit from day one, you’re building a sustainable, profitable enterprise that can weather economic ups and downs and provide long-term value. 

Need help setting up a Profit First model? North One makes it easy to create accounts, allocate funds, and manage your revenues. Take a tour of our platform today and see for yourself.