Book SummaryProfit First, by Mike Michalowicz

1-Page Summary1-Page Book Summary of Profit First

Mike Michalowicz’s Profit First criticizes traditional business accounting methods by claiming that they are unintuitive, and that their unintuitive nature leads many entrepreneurs to failure. He then outlines an alternate accounting system, which he calls the Profit First method. This method, he says, allows an entrepreneur to do their business accounting in a simple and intuitive way, and to increase their business’s profitability and stability. (Shortform note: Michalowicz claims that the financial stability offered by the Profit First method will help reduce your levels of stress, which is supported by psychological studies. Specifically, studies found higher levels of anxiety among those who have trouble properly managing their finances.)

Part 1: Defining the Profit First Method

In this section, we’ll explore the main principles of traditional accounting, Michalowicz’s argument for why they don’t work, and the main tenets of his Profit First accounting method.

Traditional Business Accounting

First, let’s clarify what Michalowicz is referring to when he talks about traditional accounting. Specifically, he’s referring to three main principles in his arguments, which he claims are the common wisdom of the business world.

1. Traditional business accounting recommends starting with income, subtracting all expenses, and labeling the difference as profit.
2. Constantly look to grow your business and put growth as your first priority. Growth leads to an increase in your income as well as the overall value of your company in case another company wants to buy it.
3. Traditional accounting also advises that you consult financial documents like balance sheets or income statements regularly, so you know what’s going on financially in your business at all times.

The Danger of Traditional Accounting

While traditional principles work for some, they also lead many businesses to failure. Michalowicz argues that this high failure rate exists because traditional accounting principles clash with the way most people think and make decisions.

(Shortform note: Research supports Michalowicz’s claim that traditional accounting methods can clash with the way people think. A study revealed that even professional accountants still allow some of their personal, unconscious bias to get in the way of their logical, rational accounting work, often turning out inaccurate results that favor their clients.)

Michalowicz identifies one major clash in particular: Entrepreneurs interpret the traditional principle that growth is success to mean they should reinvest all their money—including their profits and personal funds—back into their expenses. They think that this increase in expenses will be covered by the increased income from their larger business. However, reinvestment into growth makes a business unstable, as it creates high costs and eliminates cash on hand. This instability can make slow sales periods fatal for a business.

(Shortform note: Behavioral psychology studies on gambling support Michalowicz’s claim that people naturally think continuing to put money into their business will eventually result in success. Studies suggest that while gambling, losing money makes us want to spend again, and makes us think that doing so will earn us rewards. This research could be interpreted to suggest that if entrepreneurs are losing money growing their business, they will psychologically want to spend more money on growth to chase success.)

Challenges in Addressing Instability

The instability that comes from a rapidly growing business is also very difficult for most entrepreneurs to fix, says Michalowicz. He outlines three additional ways traditional principles clash with natural decision making and explains how these clashes prevent entrepreneurs from stabilizing their businesses.

1) Many entrepreneurs become used to the extra expenses they reinvested their profits on, and don’t want to get rid of them. They might have a hard time recognizing that they don’t need the company car or office space they have grown accustomed to, for example. (Shortform note: Research on compulsive spenders supports Michalowicz’s argument that people attach emotions to the things they buy, which makes cutting expenses much more difficult. Studies suggest that people tend to believe that buying things will make them happier, or compulsively buy as a way to try and cope with shame.)

2) Financial documents are often complex and difficult to navigate, even for accountants. This can make it difficult for entrepreneurs to even recognize when their business is financially unstable. (Shortform note: Michalowicz’s claim that small business entrepreneurs have trouble understanding their accounting is backed up by a recent survey, which found that 40 percent of small business owners would label themselves financially illiterate, and 66 percent wish they knew more about their finances.)

3) Financial instability and uncertainty often lead entrepreneurs to make irrational or panicked decisions, which only put a business into further trouble. Often, these decisions involve looking for increased growth and sales even if they come with expenses or opportunity costs. (Shortform note: Psychological research supports Michalowicz’s claim that as people lose money, they will make worse financial decisions. A study found that as gamblers lost...

Profit First Summary Shortform Introduction

In Profit First, Mike Michalowicz presents his own system of business accounting and financial management, which allocates a percentage of income as profit before calculating money for expenses. Michalowicz claims that this method allows an entrepreneur to create and maintain financial habits which will make their business more efficient, stable, and profitable.

About the Author

Mike Michalowicz is an author, entrepreneur, business makeover specialist on MSNBC, and lecturer. In the 1990s, he found initial success starting and selling two multi-million-dollar tech companies. By 2008, though, he had lost all of his money on ill-fated startups and ended up in debt. By studying his mistakes, he developed new methods and techniques to get himself out of debt and regain financial stability. Over the next decade, Michalowicz paid off his debt and now runs two multi-million dollar companies and authors books on how to run a successful business.

Connect with Mike Michalowicz:

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Profit First Summary Part 1: Defining the Profit First Method | Chapter 1: Traditional Accounting

Mike Michalowicz’s Profit First criticizes traditional business accounting methods for encouraging excessive growth at the cost of a business’s profitability and financial health. He then outlines an alternative to traditional accounting, which he calls the Profit First system of business accounting. In this method, you subtract profit from income to determine how much money you have available for expenses (as opposed to the traditional method of subtracting your expenses from your income to determine profit). This, along with other guidelines used in the Profit First method, helps you keep track of your business’s finances, increase its profitability and stability, and maintain your spending discipline.

(Shortform note: Michalowicz claims that the Profit First method’s stability and easy-to-understand nature will reduce your financial stress. Research supports this claim by indicating that financial instability and uncertainty correlate strongly with levels of anxiety and stress. This study found that those with higher levels of financial stress typically have...

Shortform Exercise: Reflect On Your Current Business Accounting

Consider if you conduct your accounting by traditional principles, and how that might affect the way you run your business.

How much has your business’s revenue grown in the past year?

Profit First Summary Chapter 2: Core Tenets of the Profit First Method

In the previous chapter, we saw four ways that traditional accounting methods can lead businesses into failure. All of those cases show that while traditional accounting depends on clear logic and rational decision-making, Michalowicz believes that the way people think and make decisions—especially when they're losing money—isn’t logical or rational.

(Shortform note: Research supports Michalowicz’s claim that traditional accounting methods don’t work well with the way people think. A study revealed that even professional accountants allow some of their personal, unconscious biases to get in the way of their logical, rational accounting work—often interpreting financial information in a way favorable to their clients, even if by doing so, they fail to recognize errors or fraud. Since even professionals have trouble remaining fully logical while doing business accounting, it’s not hard to imagine the difficulties Michalowicz suggests entrepreneurs have with managing their finances rationally.)

A preferable accounting system would allow an entrepreneur to use the existing ways they think and make decisions instead...

Profit First Summary Part 2: Setting up the Profit First Method | Chapter 3: Bank Accounting

Now that you understand the benefits of the Profit First system, we’ll discuss how to set it up step by step.

In part two of this guide, we’ll be covering the following steps:

1. Opening your new bank accounts
2. Assessing your business’s current financial health
3. Finding your business’s ideal financial situation
4. Determining how to work towards that ideal

This chapter covers step one: Opening new bank accounts. Michalowicz recommends organizing your accounting with seven bank accounts, rather than using a spreadsheet or financial software. Doing this allows you to continue your existing habit of making business decisions based on your bank balances, but you’ll also make financially healthier decisions because you’ll have a clearer idea of how much money you have available for each part of your business.

Your Seven Bank Accounts

To organize your accounting through bank accounts, Michalowicz instructs that you open five checking accounts at one bank, and two savings accounts at another, each used for one major component of your business’s finances.

Your Five Checking Accounts

You can open these checking accounts at your primary bank. Use them to...

Profit First Summary Chapter 4: Assessing Your Business’s Current Financial Health

Once you have your bank accounts set up, Michalowicz says it’s time to assess your business’s current financial health. In this chapter, we’ll outline how you can find the percentage of your income you’re spending on each aspect of your business: profit, your personal salary, taxes, and expenses. Then, we’ll provide examples of what percentage of income a healthy business spends on each category. By comparing your current percentages with the example healthy percentages, you’ll be able to assess how financially healthy your business is.

(Shortform note: While this chapter of the guide provides a simple way to assess your business’s financial health, it isn’t as comprehensive as what a skilled financial advisor can offer. Michalowicz himself mentions that you should work with your accounting team throughout the book, so keep in mind that the principles in this chapter aren’t a substitute for that kind of support.)

Using the Allocation Percentage Equation

To assess your business’s financial health, Michalowicz outlines a step by step process to find what percentage of your income you...

Profit First Summary Chapter 5: Finding Your Business’s Ideal Allocation Percentages

While the percentages Michalowicz gave in the previous section are a good general example of where a healthy business allocates its income, he also recommends that you use your business’s financials to find ideal allocation percentages specific to your business. In this chapter, we’ll cover Michalowicz’s steps for finding an ideal profit, salary, tax, and expense percentage specific to your business, industry, and circumstances.

(Shortform note: Once you determine these ideal percentages, think of them as good initial goals for your business. They shouldn’t remain fixed forever—Michalowicz acknowledges that you’ll likely make adjustments over time to your ideal percentages based on your business’s needs and circumstances.)

Finding Your Ideal Profit Percentage

To find your business’s ideal profit percentage, Michalowicz advises you use any combination of the following three methods.

Check Similar Companies’ Records

Using your financial website of choice, look up the records of successful public companies in your industry that are similar to your business’s size. Check their income statements, and optionally their cash flow statements and balance sheets from...

Shortform Exercise: Plan Your Profit First Setup

Start to plan how you can apply the Profit First system to your own business, and how it will change the way you do your accounting.

Besides using a different bank, what are other strategies you can use to make your tax and profit savings accounts difficult to access? Try to think of three.

Profit First Summary Chapter 6: Your First Year Using the Profit First Method

Once you’ve found your ideal percentages, Michalowicz says you shouldn’t try to match them too quickly—if you allocate too much money away from expenses right away, you’ll often end up without enough money to keep your business running.

This chapter will explain his methods for setting up a pattern of sustainably moving towards your ideal percentages by gradually changing how you spend your money. Michalowicz provides several techniques and financial habits which will help you accomplish this.

Changing Three Percent at a Time

First, Michalowicz suggests that when you change your current percentages to meet your ideal percentages, you start by only changing three percent. Subtract three percent from a percentage currently higher than its ideal, and add it to a percentage currently below its ideal.

• For example: An entrepreneur’s current expense percentage is 50 percent, but their ideal expense percentage is 40 percent. Their current profit percentage is one percent, but their ideal profit percentage is 10 percent. When starting the Profit First method, this entrepreneur reallocates three percent from expenses to profit, so that their expense percentage is 47...

Profit First Summary Part 3: Using the Profit First Method Long-Term | Chapter 7: Cutting Expenses

Once you’ve made your bank accounts, found your ideal percentages, and created your income allocation habits, you can start focusing on using the Profit First method long-term to improve your financial stability and profitability. In this final part of the guide, we’ll explain how to improve your business by cutting expenses and increasing efficiency. Then, we’ll explore how to maintain your financial stability by avoiding common mistakes Profit First entrepreneurs make and by adopting the Profit First method for your personal finances.

In this chapter, we’ll look at Michalowicz’s recommendation for how to cut expenses. He explains that as you increase your profit percentage, you’ll need more money available for your profit allocation. However, he emphasizes that increasing your income is not how you should get this additional money, because cutting expenses is a faster, easier, and simpler way to make money available.

(Shortform note: You might think that calling expenses simple to cut here conflicts with Michalowicz’s earlier claim that many entrepreneurs have difficulties cutting their expenses. In that case, Michalowicz is talking about the emotional difficulty of...

Profit First Summary Chapter 8: Making Your Business More Efficient

Michalowicz explains that, in addition to cutting expenses, you should also improve your business by increasing efficiency everywhere you can. In this chapter, we’ll cover his advice on how to do so by seeking innovation and focusing on your most profitable services and clients—all of which is in service of specializing in what your business does best and getting even better at it.

Search for Innovation

To make your business more efficient, you should always be looking for ways to improve via simplification, organization, and innovation. With the Profit First method, your limit on expenses forces you to find ways to do more with less. In other words, you’ll look for ways to earn more profit while using less time and money. (Shortform note: You might be wondering why working with less will help you be more creative. According to creativity coach Coleen Chandler, constraints like limited money spark creativity because they force us to approach problems in ways we aren’t used to, and being in new situations helps us think of new ideas.)...

Shortform Exercise: Consider How You Might Improve Your Business

Using Michalowicz’s standards for cost cutting and improving efficiency, determine where and how you might be able to improve your business.

Add up the cost of all of your unnecessary expenses labeled “remove.” How much money will you save by cutting these?

Profit First Summary Chapter 9: Three Common Mistakes When Using the Profit First Method

If you stick to the guidelines the Profit First method uses, you should have a relatively easy time maintaining stability and profitability in your business. However, Michalowicz notes that there are some common misunderstandings entrepreneurs have about the method, which can lead to mistakes in financial decision making. In this chapter, we’ll explain the three most common mistakes entrepreneurs make when using the Profit First method, the misunderstandings that cause them, and ways you can avoid making these mistakes yourself.

(Shortform note: When discussing potential mistakes, Michalowicz emphasizes that the biggest danger to your business once you’ve established the Profit First method is you returning to your own bad habits. If you do return to a bad habit, though, it’s important that you avoid shame—the feeling that you’re a failure, or that there’s something wrong with you. Research suggests that people who experience shame are more likely than those who don’t to indulge in their unwanted habits.)

Mistake #1: Reducing Quality

The mistake: Cutting costs by reducing the quality of products or services. Doing so...

Shortform Exercise: Prevent Common Profit First Mistakes

Plan ahead to avoid making the common Profit First mistakes Michalowicz lists.

Return to your “keep, improve, remove” marked list of expenses, or just reflect on your current expenses if you haven’t yet made a list. Which expenses would lead to a reduction in the quality of your product or service if you were to spend less on them or cut them altogether? Label these expenses as “need.”

Profit First Summary Chapter 10: Using the Profit First Method for Personal Finances

Now that we’ve discussed how to set up the Profit First system for your business as well as the benefits it can provide, we’ll outline how you can further increase your financial stability by applying the Profit First method to your personal finances. To do so, you’ll use slightly altered versions of the Profit First instructions for businesses to: Set up bank accounts, manage your debts, and build your savings.

Step #1: Set Up Your Bank Accounts

To be able to manage your personal finances through your bank accounts, Michalowicz recommends opening five:

1. Income: Where your money goes before you allocate it, just like for a business.
2. 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.
3. 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.
4. Recurring expenses: Money you use for recurring expenses like rent, utility bills, or online...

Shortform Exercise: Manage Your Personal Costs

Using some of Michalowicz’s overall Profit First guidelines, perform an assessment of your personal finances and consider how you can keep your personal costs down.

Separate your monthly expenses into two lists: one for needs (basic food, housing, transportation, etc.) and one for wants (entertainment, eating out, hobbies, etc.).