This article is an excerpt from the Shortform book guide to "Profit First" by Mike Michalowicz. Shortform has the world's best summaries and analyses of books you should be reading.
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Do you want to learn how to manage your finances? How can you apply the Profit First method to your personal finances?
The Profit First method was created by entrepreneur Mike Michalowicz to help businesses succeed in the long term. However, the three principles of the Profit First method can be applied to your personal finances to help you get out of debt and save money.
Keep reading to learn how to manage your finances and increase your financial stability by following Mike Michalowicz’s Profit First method.
Step #1: Set Up Your Bank Accounts
In his book Profit First, Michalowicz explains how to manage your finances using the Profit First method. The first step is to open five bank accounts:
- Income: Where your money goes before you allocate it, just like for a business.
- Emergency: Your eventual goal is to have enough money in this account for eight months’ worth of living expenses with no income. Early on, though, try to just put together one month’s worth.
- Daily expenses: Money you use for non-recurring expenses like food, clothes, or home repairs. Determine how much money you’ll need for a given month, then allocate half of that amount to this account every two weeks.
- Recurring expenses: Money you use for recurring expenses like rent, utility bills, or online subscriptions. Total up all of these expenses, then allocate that much money to this account each month.
- Debt repayment: All remaining income after your other allocations will go to this account, and will be used to pay back your personal debts.
| Alternative Options for Personal Bank Accounting Michalowicz isn’t too specific when talking about how you might allocate your personal income to these bank accounts. For more details on where to put specific portions of your income, you can look to Scott Pape’s The Barefoot Investor. While some of his recommendations are similar to Michalowicz’s, he also offers three specific guidelines for allocating your personal income: 1. Managing necessary expenses: Pape recommends you allocate 60 percent of your income to necessary expenses each month and work to keep your necessary expenses at or below that amount. 2. Managing unnecessary expenses: Pape recommends making separate bank accounts for unnecessary expenses—things like entertainment, pleasure, or hobbies. Specifically, he recommends you make a “Treat” account for day-to-day entertainment (like drinks with friends) as well as a “Happy” account you use to save for larger entertainment costs (like a vacation or new car). He recommends that you allocate 10 percent of your personal income to both of these accounts each month. 3. Managing debt and emergencies: For the last 20 percent of your income, Pape recommends allocating it towards paying off debt and maintaining an emergency fund—in Michalowicz’s system, this money would go towards your emergency and debt repayment accounts. |
Step #2: Manage Your Debt
These are two extra guidelines Michalowicz offers for paying off personal debts like student loans, your mortgage, or credit card debt.
Pay From Smallest to Largest, and Shortest to Longest
First, Michalowicz advises you pay your debts from smallest to largest just like you would for your business. In addition, focus on more immediate debts first before worrying about longer-term debt. Doing so helps to build your confidence before taking on larger, more intimidating debts.
- For example, focus on your credit card debt or student loans before trying to fully pay off your mortgage.
(Shortform note: While Michalowicz only discusses how to pay down your debts, David Bach’s The Automatic Millionaire suggests methods that will ultimately reduce the amount you’ll have to pay overall. To do this, he advises you to negotiate with your credit card company for a lower interest rate, consolidate multiple debts into a single, low interest account, and automate your debt payments so you never miss them.)
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- Why traditional business accounting methods don't work
- How to use the Profit First method to increase your business’s profitability and stability
- How to assess your business's current financial health
