How Putting Profit First Prevents Entrepreneurial Crises

I possibly could have avoided a million-dollar bank scare with the strategies in Mike Michalowicz’s book, Profit First.

Years back, I got the type of letter that entrepreneurs never want to get. It was a qualified letter from my bank saying that they no more wished to be my company’s lender, and requesting Personally, i deliver $1,411,400.10 with their offices within two days. I didn’t have a million dollars and couldn’t have raised a fraction of this amount even easily had sold my home, my car and any non-essential organs.

My business partner got the same letter, too. So did our spouses. The lender was invoking the non-public guarantee that people had signed years earlier to close on a credit line.

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That was probably the worst day in my own business life. In a decade, we’d gone from a bootstrap startup to an effective 8-figure business in the growing family computer market. We’d built an office and warehouse facility that was both highly efficient and, inside our eyes, beautiful. We employed a large number of people. Other entrepreneurs sought our advice.

There have been many factors that brought us to the financial impasse. Our bank had opted through two consecutive acquisitions. Rather than the local, entrepreneur-friendly bankers we’d dealt with for a long time, now a faceless loan committee in a distant city was deciding our fate. We’d been a person for our entire history rather than missed a payment, however the committee decided they didn’t like our numbers. Game over.

Inside our core business, meanwhile, the global brand that was our largest supplier and the driver of sales for most of our other brands was itself teetering on the edge of bankruptcy. Product introductions were delayed, shipments were erratic, and market support was rapidly eroding. Revenue growth went from positive to negative.

While these external factors were important, a lot of the blame for the dire situation we found ourselves in rested with just how we built the business enterprise.

For a lot more than 10 years, we’d focused primarily on growth. Each year, we’d double-digit increases in sales. Instead of pay taxes, we spent the gains we eked from things we thought would help us grow even more quickly. We thought that to be viable, we had a need to break the $100 million sales barrier, an objective achievable in just some more years.

According to author Mike Michalowicz, writer of Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, our approach was the entire opposite of what it will have already been. By not putting aside an acceptable profit every year, we set the stage for our eventual bank crisis.

Revenue doesn’t cause you to a viable business, as our strategy implied. Profit does.

So, what’s profit? Check any business textbook, and you’ll find that profit is what’s left when you subtract expenses from revenue. The math is easy and intuitive, and almost every entrepreneur knows that formula. Here’s the problem: that equation is an integral part of why so many young businesses fail.

In Profit First (newly released in a revised and expanded edition), Michalowicz turns that long-established equation on its head. His math can be simple — expenses are what’s left once you subtract benefit from revenue.

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That concept seems strange. We think about expenses as unavoidable — cost of material, for instance. Rent, salaries, utilities etc seem equally intractable, at least in the short run. If we didn’t have to devote to something, we wouldn’t, right?

Actually, the discipline of putting away a share of revenue for profit and spending only what’s left is why is Michalowicz’s concept work. Expenses actually could be avoided, eliminated or delayed. Doing which can be uncomfortable, of course. It could mean some spending for growth doesn’t happen immediately. Better processes should be developed. Sometimes, difficult decisions about people and positions should be made.

It really is counterintuitive, but Michalowicz says a profit-first approach is really growth-friendly. When you encounter a really attractive opportunity which will increase revenue and profits, you should have the resources to purchase it without endangering the existing business. Whenever a business with out a profit cushion plows every spare dollar back to the business enterprise, much as we did such a long time ago, it really is planting the seeds not for growth but also for another crisis.

In the years that led up to my $1.4 million demand letter from the lender, we could have already been far more profitable. A few of our growth-oriented “investments” never returned a fraction of their cost. We increased our inventory using our credit line whenever we could have freed up cash by aggressively clearing out slower-moving items.

Profit First may be the book I wish I had when I began my entrepreneurial career. It describes both a philosophy and something for building businesses in a sustainable way that creates long term success. The philosophy is that one items — profit, taxes, and owners’ pay — are accounted for first. Then, what’s left is what the business can spend on the rest.

Naturally, the percentages for profit and owners’ pay should be reality-based, particularly in the first phases of a venture. One can’t arbitrarily set a profit level inappropriate for the industry and expect it to magically happen.

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Undoubtedly, the hardest part of Michalowicz’s prescription is making costs fit the available money. Fortunately, a big chunk of Profit First is specialized in ways of growing margins and reducing expenses. The book shows how even apparently fixed expenses could be cut and that increasing income can often be a smart choice.

From hiring and firing practices to eliminating low-profit clients, Michalowicz outlines simple techniques which can be applied in virtually any business. Some steps could be painful, however the discipline of limiting expenses while protecting profit makes the pain worthwhile. The book is sprinkled with examples showing how tough decisions brought businesses back from the brink of disaster.

Michalowicz covers some areas of accounting, however the book is certainly not about debits, credits and ledgers. Because the first edition of Profit First premiered, some accountants have formally adopted its approaches for their clients. According to Michalowicz, the amount of entrepreneurs using the machine is currently in the thousands.

The Profit First philosophy and system for building businesses could have prevented at least a few major pain points in my own ventures. Had I adopted those practices, who knows how outcomes could have differed?

The ultimate chapter of my $1.4 million crisis might have been far worse. We slashed costs, liquidated inventory, built on profitable segments, and finally paid off the lender. We never had to provide any personal assets. But, the stressful workout process permanently changed the business. We sold our custom-designed building. Long-time employees were release. The business enterprise itself emerged as a greatly diminished entity with a different business design than my co-founder and I had pursued. Both of us left the business enterprise and continued to entrepreneurial success in divergent fields.

Right now, I keep carefully the original bank letter in a frame on my office wall. On days when I believe things aren’t going well, I look into it to remind myself just what a bad day is really.

Profit First came a little too late for me personally, but in the event that you know a business owner or struggling business proprietor, provide them with the book. It’ll change their business and, po

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