Today I'm talking about how to get a handle on and take charge of the financial cash flow of your business so that money, specifically cash flow of money, isn't a stress point or something that you avoid in your practice.
Now, I've seen this consistent concern from numerous doctors in my Functional Lawyer Membership and in general conversation with other doctors: cashflow is a stressful part of running a business. This is very common with small business owners, and I’ve seen it firsthand at Functional Lawyer and through my wife's functional medicine practice.
Today, I have a recommendation that will help you take charge of your cash flow so that you're not in a place where you're unsure if you can pay bills this month or worried that there's not going to be enough money at the end of the month for you to pay yourself.
The tool that I recommend, and this is a system that I've implemented at Functional Lawyer because it works so well at Origins Functional Medicine, my wife's practice, is the Profit First system. Profit First is a book by Mike Michalowicz, and it's really a cash flow and management system that teaches you to change the way you approach the cash flow in your business.
Two things to note before continuing:
Most of the time, in business textbooks or anytime you hear the word "profit" from an accountant or an accounting firm, they'll say, "Well, profit is just income minus expenses. Income minus expenses, whatever's leftover is the profit."
Basically, the default way to calculate profit is:
You've also probably heard somebody say to pay yourself first. Pay yourself first; set money aside first.
But as you know, human behavior doesn't work like that. It's a lot harder to do this in practice.
Mike Michalowicz teaches a system in which you create behavioral change and you actually do pay yourself first. You get the income, you set aside money for profit, tax, and owner’s pay, and then, whatever's left over is what you have for expenses.
Profit First method:
Once we implemented this system into our businesses, our financial peace of mind was so much better. We now know where the money is going and where it's coming from. We know that we have some set aside for rainy days, or if an opportunity comes up that we can really invest in the business and make it grow.
And, this system is very beneficial come tax time. With this system, you won’t have to worry about a surprise tax bill because you will have set money aside throughout the year.
I'll give you a brief overview, but to fully understand it and implement it, you really should get the book as Michalowicz provides step-by-step instructions,
How to begin to understand it, in a nutshell, is this: Typically, when money comes into a business, income will come into the checking account, but then the business owner also pays bills out of that checking account. Then at some point, often towards the end of the month, they take some money out as the owner, and they move it to either savings, or they put it in their personal bank account. That might work if you're disciplined enough or have an accounting brain that can mentally see where all your money is going. But, for most of the rest of us who aren't finance majors, that is a difficult way to run a business and know where all the money's going and know that you're going to have enough to cover all your expenses and pay yourself consistently.
What the author, Mike Michalowicz, recommends takes a little bit of work to set up, and it takes a little bit of time to understand it. But once you do, it will completely change your relationship with cash flow in your business. It will be smooth sailing. It did so for us, and I'll give you an example of that.
A couple of years ago, we had a tax bill that came back from our CPA who prepared our taxes. We were shocked to learn that we owed around $10,000. It was stressful because we frankly didn't have $10,000 set aside in the business to just pay that lump sum. We had to find it and put it together and pay that tax bill.
But, fast forward to last year where I was anticipating a bill of something like $40,000. I was ecstatic to find out our tax bill was only $20,000. Thanks to the Profit First system, I knew we needed to set aside a percentage of our gross income, and I was prepared to pay a sum closer to $40,000.
Now, a lot of things go into determining your tax liability, whether you're paying it quarterly or monthly estimated payments. And I am not a CPA, so I leave that to them. But the point of my story is that we were prepared to pay a larger sum, and we had the funds set aside to do so. This time around, we were pleasantly surprised and completely prepared, not shocked.
This is a good time to stop and say you should really plan out your tax liability during the preceding year. Get with an accountant; get with a bookkeeper, and really figure out how you can minimize, set aside, and make estimated payments-- before your liability grows and you get a surprise bill come March 15th. As for my wife and me, we hadn’t dialed in our estimated payments yet, so I was prepared to pay a larger liability.
What Mr. Michalowicz recommends is basically having four or five bank accounts for your business. When money comes into your bank, rather than going into one big bucket of a checking account, it gets deposited into an account just for income. Then, periodically (e.g., twice a month), you distribute that money, the revenue that you've made, into your other accounts. For the most part, you can put your bank accounts in four different categories.
One category is “Owner Pay” or what you take home. Put money in there first. Then, you put some money into a “Profit” account. Then, you set aside some money for taxes in a “Tax” account. Then, in the end, whatever's left over goes into the “Operating Expense” account.
What you put into each of those accounts is based on some percentages and formulas that Michalowicz explains in great detail in the book. For example, you could put 50% into Owner Pay, 5-10% into Profit, 15-20% in Taxes, and then about 30% into Operating Expenses. If you don't know what your operating expense percentage is right now or what those percentages are today, the book helps walk you through how to figure that out and then how to get those percentages closer to your target numbers so that you're paying yourself a little bit more, you're setting aside money, and you finally have control over your finances!
While it did take me a bit to wrap my head around the proposition that five bank accounts are easier than two, it is not that complicated. Once you get it set up, it is very easy to execute, and it turns a stressful, sometimes painful, part of entrepreneurship into a strength for your businesses.
Do you have a money management system that really works for you? Let me know in the comments below.
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