Episode 005: An Introduction to Cash Flow Management

cash flow solo show Oct 29, 2019

On this episode, I chat about the Profit First book, and how I recommend getting started implementing a cash flow system into your business.

If you want more info on s corps, check out this blog.

Episode Transcript

Braden: (00:00)
Hello and welcome to episode five of the unpack your biz podcast. I'm your host Braden. Super excited to have you here. This episode is going to be an introduction to the profit first system. So if you're not already familiar with profit first, it is a book written by a man by the name of Mike Nicalo [inaudible] on how to manage the cashflow in your business. So I really like this system. I'm going to break it down here on the podcast by going through my free download that is called the getting started with profit first roadmap. So I highly recommend if you want to start implementing this system into your business, check out the audio book. That's kinda my favorite method. Uh, Mike does the audio book and he provides a lot of examples and context that is not in the physical copies. So the audio book is great.

Braden: (00:51)
You can also buy the book at pretty much all major book retailers and on Amazon of course, so you can start there. Um, but also if you want a quick start guide, go to unfuck your biz.com click freebies and download. My getting started with profit first roadmap. That's what I'm going to walk through on this episode. And then if you get the freebie, you can see a much more visual example of what I'll be chatting about, which will be helpful to you. All right, so let's dig in. Why use this system? So I've found that it's supernatural for us small business owners to increase our expenses as we increase our income, we get a new client, we download new software, we get a new sale, we sign up for that retreat we've been wanting to do. We get another new client and then we buy new equipment.

Braden: (01:43)
Like a computer or a camera. You get the picture, and year one, your income might be $1,000 a month and expenses are 200 so that's awesome. Expenses are only 20% of your total revenue. You are profiting $800 six months later you feel like you're killing it. You're getting more clients, but all your money is gone. You're making $4,000 a month, but now your expenses are $3,000 so without really realizing it, you're now spending 75% of your revenue on expenses and your take home pay has only increased by 200 bucks. Then you're making $10,000 a month, a maybe a year later, but your expenses are now a $7,000 so 3000 is still three times more than you were taking home your first year, but your revenue has increased by 10 times. So you would expect your take home pay to increase the same. You're making more money and the bills are getting a little bit easier to pay, but with the larger jump in income, you're wondering why money is still a struggle.

Braden: (02:47)
Like why don't you have extra money to put towards vacation, retirement, all those sorts of things. The idea of the profit first system is to set targeted percentage for how much you're going to pay in taxes, how much you will pay yourself, how much you will set aside for profit. And then perhaps most importantly, how much you're gonna pay an operating expenses. The idea is to put a stop to this habit where you let your expenses catch up with your income before you really start to grow your business. So it's laying a solid foundation for healthy growth. So in the book, Mike talks about the typical accounting formula. He calls it the broken, the broken formula the most finance professionals will use, which is income minus expenses equals profit. That's the standard formula. You've all probably seen it before and an expense, but Mike suggest that we flip the script and start using the formula.

Braden: (03:46)
Income minus profit equals expenses, and this is where the whole concept of profit first comes from. So you look at your total revenue, you take out your profit and you set it aside for yourself. And then whatever's left over is your expenses. That's your budget for expenses. So profit first is kind of akin to the envelope system, if you're familiar with that. I have one family member and aunt to uses the envelope system. Every time she gets paid, she cashes her paycheck rather than having a direct deposited and she puts a certain percentage into an emergency envelope. She puts 5% into her Christmas envelope, 10% into the groceries envelope. You get the picture profit first is like that, but uses bank accounts instead of envelopes for small business finances. I teach a modified system that uses three bank accounts. So Mike suggests the seven accounts, I prefer three a most professionals you talked to who teach profit first will have their own kind of modified system.

Braden: (04:57)
But I'm going to show you mine. So what you do as you open these accounts, and then on the 10th and 25th of each month, you go into your primary bank account, which is called the income account, and you make distributions to your owners, pay an operating expense accounts. I then recommend a couple of magical tools to automate savings for profit and taxes. And that's the gist of this system. So why I love this system and why you should look into using it. So my goal for every one of my students and my courses, my members and my membership and my clients and my law firm is for them to eventually scale into an escorp if they're already established business owners. We want to do this within a year. If are new business owners, the goal is to do it in three years. I'm not going to fully explain how escorts work here on the podcast.

Braden: (05:51)
I'm going to give you kind of the intro version. If you want the details, go check out my blog on escorts. I will link that in the show notes for you, which you can find at [inaudible] dot com forward slash episode forward slash zero zero five so the way [inaudible] works is you put yourself on payroll, so you actually hire a payroll company. That money is automatically withdrawn from your business bank account and sent to you via a paycheck every two weeks that you can have auto deposit into your personal bank account. So it seems silly. You're basically paying a third party to auto withdraw money and deposit into your personal bank account. The reason why you have a professional company do that is because they automatically withhold all the payroll taxes, Medicare, social security, that kind of stuff. So you don't have to worry about it.

Braden: (06:44)
They also file payroll tax returns. So these paychecks are your earnings for working for your business. You are an employee of your own business and that's what your payroll is for. But then on a quarterly basis, as the owner of an escorp, you take profit distributions on top of your compensation. That is your reward for being the owner of your business. And the way the escort works, this is kind of the magical part, is these quarterly distributions are subject to a lower rate of tax. You don't pay Medicare and social security taxes on that. And that's why as corpse are great, why you should all strive to have one once you're ready for another analogy, I always like to explain, if you are Tim cook, CEO of Apple, you probably own a lot of stock and Apple. So you're not only an employee of the company that gets a salary and regular paychecks, you also are going to get uh, owner's distributions.

Braden: (07:44)
And if a share in the, uh, form of dividends, and it works the same way when you are the sole Eleanor of your small business, you are the owner. So you get profit distributions and then you also are an employee that gets owners compensation. So just to boil it all down for you, most business owners will start saving money with an escorp once they're profiting. So profit being the keyword here North of around $60,000. The biggest hurdle icy with business owners is that they let their expenses grow and grow. So while they're bringing in great revenue, their profit margin is not so great. They also don't have consistent cashflow policies and procedures in order to put themselves on a consistent payment schedule. So maybe you're a wedding photographer, you are going to make $10,000 a month during peak season, but then there are some months where you only make $1,000.

Braden: (08:43)
If you don't have great cashflow policies, then it's going to be difficult to commit to paying yourself $1,500 every two weeks because you're spending a lot of money when the money's coming in from the clients and then you're kind of cash poor during those slower months. And the idea of this system is to fix that cycle so you can eventually get on payroll and save some taxes. In other words, just to boil this all down, you can make a shit ton of money and your business, but if your finances and your cashflow are a clusterfuck, then you cannot streamline your processes to save tax money. Implementing a system like profit first early on in your business makes the transition into an escort seamless because you're already paying yourself routinely through the system we're about to talk about. So now that I kind of got the intro out of the way, hopefully you're sold.

Braden: (09:39)
Uh, if you're not sold, definitely go read the book. If you are sold, keep listening. Now we're going to go through what I call the profit first roadmaps. So these are my six steps to get started. Implementing the system. Step number one is to add up your expenses and make some cancellations. So open three months of bank and credit card statements for your business and then write down all recurring expenses you have. So for example, in my business, I pay $15 a month to count only $30 a month at the Sato, $15 a month to zoom. I pay office rent on a monthly basis. You get the picture. So write all that down and if there's anything that you definitely are not using that you don't need anymore, cancel it. So I had in my business, I was paying $50 a month for Adobe creative cloud.

Braden: (10:31)
I did not know how to use any of that software or after paying for seven months, it was pretty clear I was never going to get my shit together to actually use it. So I canceled it. So boom, there's $50 I'm saving. Another top tip for you as a lot of these programs will require you to chat in with a customer service to cancel. And then they were offering you a discount or a one to three free months. So Adobe actually offered to put my account on a pay freeze for three months, but still allow me to use the software. I went ahead and canceled it. But if you want to save some money for a few months or for the lifetime of your subscription to these services, that's kind of a great trick that you can do. I also called my phone carrier and got my bill down $30 a month by taking away some features that I frankly didn't even know I had.

Braden: (11:25)
So it's good to look into every single recurring expense you have. I ended up trimming out about $200 in monthly expenses, which was huge. And now I can be more profitable once I start to bring in more business. I'm going to redirect that to my first part time contractor. So super good tip there. Step number two, after you add up your expenses, find your expense targets. So now you're going to look at all other predictable business expenses. So these are the expenses that are not on recurring payments, but that you can consistently rely on. So let's say you go to two client lunches per month on average, maybe have one one month, three one month you're going to average, you know, 30 to $40 a month in a lunches with clients and maybe you know, $50 a month for a certain kind of good or gifts for clients, that sort of stuff.

Braden: (12:20)
So average that out, add it to your total recurring expenses that you now have remaining after you've canceled some stuff. And then once you get that total figure out what percentage of your business income is going towards your expenses each month. So again, you're going to have to make a lot of estimations here, but you can ballpark it if this number feels Heidi, you then try to cancel some more things. So for a lot of service based business owners, we should be targeting around 30% of income to expenses. When I did mine, I think I was at 50% so it was time to cut some stuff. So just keep that number in mind. In the book. Mike goes through a much more sophisticated system on how to calculate what your percentage should be. So check that out if you want more details. Step number three is to open up your bank accounts, so determine how many bank accounts you need.

Braden: (13:16)
I recommend the following accounts at business income account and owner's pay account and operating expense account, and then whatever personal accounts you want for your personal finances. So that's three for your business and then your personal stuff. Most business owners already are going to have or already should have a business account and a personal account so they only need to open two more. Step number four is to set up automations. The profit first book recommends two additional bank accounts called tax and profit. And then two more. I'm not going to get into details, but basically seven total. I like to simplify and automate by using a couple of phone apps. So one is called catch one's called [inaudible]. Uh, I have referral links for these that I will put in the show notes with a little bit more detail. If you use my links, it's one of those things where I think like I get 10 bucks, you get 10 bucks, you know how that works, but you can go check that out and then they link to your bank account to automatically withdraw money for your profit and your tax savings every time money hits your bank.

Braden: (14:31)
So essentially the way the system works is a client pays you $1,000, you have this app set up to set aside 20% for taxes, 10% to profit. So 200 automatically gets pulled to go in your tax savings account. 100 gets pulled to go into your profit account. There is now $700 and on the 10th and 25th of each month you're going to go divvy that up into your other two bank accounts as instructed. So step number five is coming up with what I call your cashflow policy. So create a personal cashflow policy. This is your step by step instruction that specifies how much and the order in which you will transfer money into your different bank accounts. I like to have a policy because it's basically setting rules and guidelines for yourself and then also you don't have to go through all of this math and steps twice a month.

Braden: (15:29)
You just look at your policy and go through the steps. If you use a system like Trello or Asana, it's great to put it in there. I have a board which essentially has all my workflows in it with a checklist. I opened that up and just go through the steps. Step number six and the roadmap is to execute your tasks. So once your cashflow is rolling and you have your accounts open, all you need to do is follow your policy on the 10th and 25th of each month. You're going to have those taxes and profits on automation, so you don't even need to worry about those, but then you'll go in twice a month and pay money to yourself into your owner's comp account and then you will put money into your operating expense account to cover your monthly overhead

Braden: (16:14)

Braden: (16:15)
So that is the profit first roadmap. I have a in this outline that I'm looking at and going through on this podcast, my banking map, so if you're more visual person like I am, you can check that out. It's kind of like a web chart showing you how the cash flow should flow through your bank accounts. And then I also have a written example of cashflow policy you can look at as well. So again, unfuck your biz.com is where you're going to find the freebie. You can download that. I'll also link it in the show notes along with the different phone apps I recommended. This was kind of the one Oh one version of profit first. If you really like this or you're curious to learn more, I'm actually going to have more podcast episodes coming out where I interview other creative small business owners who have implemented profit first and their business. So we're going to talk about their expenses, how they've started to decrease them, how they manage their bank accounts, all that kind of stuff. I'm very excited about it. Hopefully you will tune in to those as well. If you liked the episode, don't forget to leave a review and subscribe if you want to be notified when the future episodes come out. Thanks so much for tuning in. Hope this was helpful and I will be back in your ear buds, um, shortly. Have a good day. [inaudible].

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