Entrepreneur Coaching: Ensuring Profitability and Financial Health

Module 2: Ensuring Profitability and Financial Health

  • Goal: Implement the Profit First method for effective cash flow management and financial stability.
  • Summary: Introduce the airplane model (from Donald Miller’s Business Made Simple) and the Business Hierarchy of Needs (from Mike Michalowicz’s Fix This Next) to identify critical business areas. Set up bank accounts to prioritize profit, taxes, and operating expenses, ensuring disciplined cash flow, profitability, and tax preparedness.
  • Outcome: Participants develop a sustainable financial strategy and apply the Profit First system to build consistent profitability.
  • Suggested Read Before: Profit First, The Psychology of Money
  • Reference: The Goal, Secrets of the Millionaire Mind, Business Made Simple, Fix This Next

Objective: Equip participants with a solid financial foundation by implementing the Profit First system to ensure consistent profitability, proper cash flow management, and tax readiness. Participants will learn how to prioritize profit, efficiently allocate revenue across core financial needs, and create disciplined financial habits to support business stability, growth, and long-term financial health.

Section 1: The Business as an Airplane

Before we dive into the specifics of managing cash flow with the Profit First system, it's important to understand how your business functions as a cohesive whole. One helpful analogy is to view your business as an airplane. This concept, popularized by Donald Miller in Business Made Simple, helps break down the different components of your business, illustrating how everything must work together to ensure success.

Think of your business as an airplane, where each part plays a vital role in keeping it in the air and on course:

  1. The Cockpit (Leadership) The cockpit represents leadership-this is where you, as the entrepreneur, navigate and guide your business. Effective leadership is critical for strategic direction, decision-making, and keeping everything aligned with your vision. We will talk more about this in the last module of the course. (Building a Team and Delegating)

  2. The Wings (Products and Services) The wings are your products and services. High-quality, well-designed products give the business stability and allow it to soar. Without strong wings, the plane would never leave the ground. We will talk more about this in Module-3 (Identifying Profit Drivers).

  3. The Engines (Marketing and Sales) Your marketing and sales efforts are the engines that power your business forward. Effective marketing helps attract customers, while strong sales ensure you convert those leads into revenue. Without these, the business may struggle to gain altitude. We will talk more about this in Module-4 (Marketing and Sales - Your Business Engines).

  4. The Body (Overhead Costs) The body of the plane represents your operating costs or overhead. The goal is to keep this as lean as possible-heavy, bloated overhead will weigh the plane down and consume too much energy (cash flow). We will talk more about this in Module-5 (Financial Management and Profitability)

  1. The Fuel (Cash Flow) Cash flow is the fuel that keeps your business flying. Without fuel, no matter how strong your engines or how stable your wings, the business will crash. This is where Profit First comes into play-by ensuring that your business always has the right amount of cash in reserve, you prevent running out of fuel mid-flight. This is what we will focus on now. In my experience this is the most common problem for small businesses; if we can fix this as quickly as possible we will sleep better.

We will go through all these parts of the business in this course, but before we do that lets look at a model that can help us identify the most important thing to fix first.

Section 2: Understanding the Business Hierarchy of Needs (BHN)

Objective: Identify and address the most critical need within your business to promote growth.

Introduction to BHN: Inspired by Maslow's Hierarchy of Needs, Fix This Next by Mike Michalowicz introduces a framework for diagnosing and fixing the most pressing needs of your business. Just as humans have basic physiological needs before they can reach self-actualization, a business must build its way up through foundational needs before pursuing long-term impact and legacy.

The BHN levels include:

  1. Sales: The lifeblood of your business; this focuses on generating consistent, predictable revenue. Without sales, nothing else can be sustained.

  2. Profit: Profit ensures stability and long-term viability by managing expenses and setting aside income beyond day-to-day operations.

  3. Order: Building efficient systems and processes to allow the business to run without being dependent on any one person. This creates stability and scalability.

  4. Impact: Delivering on your promise to the market. At this stage, the business is making a meaningful difference, and the focus is on the value delivered to customers and the community.

  5. Legacy: Creating a business that can operate beyond your personal involvement, fostering a lasting impact for future generations.

The Sales Level

Sales is the most foundational level of the BHN. According to Fix This Next, the Sales level has five core needs to address. I have a slightly different focus of each of theses needs but the basic idea is the same.

  1. Shareholder Dividend:

    • Question: Are the sales of the business enough to support shareholder dividends in line with business valuation goals?
    • If you did your homework from module one you should have a good idea what these goals are.
    • Since you as a small business owner generally is one of the largest shareholders this ensures you can have a comfortable lifestyle, in addition to your salary which I also recommend that you take out. Swedish pension and tax systems makes it beneficial to have a moderate salary plus shareholder dividends. We will talk more about taxes and tax optimization later.

  2. Marketing:

    • Question: Are you searching for and collecting leads?
    • Consider how effectively you're reaching potential customers and whether your marketing efforts are producing results.
    • Do you have a marketing funnel? More on this in the Sales and Marketing module.
    • Are you getting the right leads?

  3. Sales:

    • Question: Are you closing the sales?
    • Your sales process and pitch should be strong enough to turn leads into actual revenue.

  1. Delivery:

    • Question: Are you able to deliver what you sell, and on time?
    • It’s crucial that sales are matched by the capacity to fulfill orders and maintain customer satisfaction.

  2. Collection:

    • Question: Are you being payed in time?
    • Cash flow is directly impacted by how quickly and reliably you collect payments from clients.
    • Do you have the right customers (i.e. customers who pay on time)?

Normally, each of these five elements of Sales needs to be operating effectively before moving on to address Profit and the higher levels of the hierarchy, but we will go through the profit level and do some simple adjustments in how we handle money. These tricks are so simple so it is easy to start with them now even if we have identified problems in the sales level. Once these simple tricks are in place we should focus on any problems in sales.

The Profit Level

  1. No or Minimal Debt

    • Questions:
      • Are you paying down debt faster than accumulating it?
      • Is your interest rate manageable, or does it eat into profits?
    • Measurement:
      • Track debt-to-income ratio monthly.
      • Monitor debt reduction rate.

  2. Net Profitability

    • Questions:
      • Are your costs of goods/services impacting profitability?
      • Can you improve efficiency without compromising quality?
      • Is the pricing right?
    • Measurement:
      • Gross profit margin percentage.
      • Cost of goods sold (COGS) vs. revenue trends.

  3. Transaction Frequency

    • Questions:
      • How often do repeat customers buy from you?
      • Are your offerings promoting upselling or cross-selling?
    • Measurement:
      • Track average customer purchase frequency.
      • Monitor repeat purchase rates.

  4. Leverage

    • Questions:
      • Is your investment in employees, tools, or marketing yielding ROI?
      • Are there activities/processes draining resources without results?
    • Measurement:
      • Return on investment (ROI) for key business activities. (Sales, Marketing, Production)
      • Cost-to-revenue ratio for marketing or operational expenses.

  5. Cash Reserves

    • Questions:
      • Are you building an emergency fund sufficient for 3-6 months of expenses?
      • Can you maintain reserves without affecting daily operations?
    • Measurement:
      • Cash reserve ratio (cash vs. monthly operational costs).
      • Reserve growth rate compared to revenue.

Section 3: Aligning the Profit First System with the Airplane Model

The Profit First system helps you ensure that your fuel (cash flow) is always well-managed. By creating separate bank accounts for profit, taxes, and expenses, you’re creating some financial tactics that ensures your plane (business) continues to fly smoothly. Each time revenue comes in, it’s distributed into different accounts, ensuring that fuel is allocated for future growth, emergencies, and operational costs.

In the same way that pilots need to monitor fuel consumption to ensure they reach their destination, business owners must manage cash flow to keep their business on course.

Outcome: Understanding the Connection Between Cash Flow and Business Structure

By viewing your business through the lens of the airplane analogy, you’ll gain a deeper understanding of how managing your fuel (cash flow) through the Profit First method ensures long-term success and sustainability. In this module, we’ll begin by setting up separate bank accounts to help you control the flow of fuel within your business, ensuring each part of the airplane operates efficiently.

Section 4: Understanding Profit First

Objective: Dive into the Profit First methodology, emphasizing its importance in building and maintaining business profitability by prioritizing profit over expenses.

The Profit First Concept: A Fundamental Shift

The Profit First system changes the way businesses handle finances by flipping the traditional accounting formula. Instead of viewing profit as the residual ("Income - Expenses = Profit"), it emphasizes the principle "Income - Profit = Expenses." This ensures that profit becomes a key focus, making the business more sustainable and financially healthy from the start.

By allocating a fixed percentage of revenue into a "Profit" account first, followed by allocations to other financial priorities, businesses can ensure consistent profitability and avoid cash flow pitfalls.

The Four Core Accounts: Streamlining Cash Flow

While the original Profit First model suggests five bank accounts, I advocate for a streamlined version with four core accounts. Here's how each functions:

  1. Income Account: This is where all revenue enters the business. Think of it as a holding account where you can see all incoming cash flow before it's distributed.

  2. Profit Account: A percentage of every revenue deposit is set aside here. This is the reward for your business's efforts and is crucial for building reserves, paying off debt, and creating long-term sustainability.

  3. Taxes Account: This account sets aside money to cover your tax obligations. Since taxes are often a surprise cost, regularly moving a portion of income here ensures that you're always prepared and reduces stress when tax payments are due.

  4. Operating Expenses Account: Unlike traditional expense management, the operating expenses come last. After ensuring profit and tax obligations are covered, what's left is transferred here to cover all business expenses, including salaries, utilities, rent, and other operating costs.

Note: I include the owner's salary as part of the Operating Expenses Account. This ensures that owner compensation is treated like any other fixed expense and doesn't disrupt the distribution model.

Optional Fifth Account: Cash Reserves

Although not part of the four core accounts, it's wise to create a Cash Reserve Account. This account can hold funds separate from profit, providing a buffer for emergencies or future investments without tapping into your profit account. It's essentially your business's rainy-day fund.

Mindset and Habit Shifts: Prioritizing Profit

Implementing Profit First requires a mindset shift. It means breaking the habit of spending first and profiting later. The focus is on disciplined, proactive financial management by setting aside profit and taxes before paying expenses, ensuring that profitability becomes a natural part of business operations. Regularly assessing and adjusting the percentages allocated to each account can help adapt to business growth and changes.

By consistently moving funds into these accounts upon receiving revenue, your business can become more financially stable, predictable, and profitable, making growth and sustainability easier to achieve.

Section 5: Practical Profit First Setup

Exercise 1: Setting Up Your Bank Accounts

  • Goal: Set up the four core bank accounts.
  • Instructions:
    • Guide participants in creating Income, Profit, Taxes, and Operating Expenses.
  • Outcome: Have these accounts ready for managing cash flow.
  1. Income Account: An ordinary business account with BG and PG connected to it.
  2. Profit Account: A savings account that can give interest.
  3. Taxes Account: This account can be set up to receive payments from your account att Skatteverket.
  4. Operating Expenses Account: An ordinary business account. This is the money you have to spend on salaries, suppliers, marketing, sales and everything else. If there is no money here then you can not buy anything. (Or you will end up with a loss and in debt).
  5. (Optional) Cash reserve: A savings account where you keep 3-6 month of operational expenses. Once you are out of debt, you can start transferring a percentage of the income here until you have a safe buffer.

Exercise 2: Profit Allocation

  • Goal: Help participants determine allocation percentages.
  • Instructions: Guide participants in deciding how much of their revenue should go into each of the five accounts.
  • Outcome: Clear allocation strategy for each account.

The Profit First system recommends setting specific percentages of revenue allocated to each account, here is my sugggested allocation strategy.

  1. Income Account: All revenue is deposited here. Connected to your Bankgiro in Sweden. If you have other income streams like swish it should also go here. Lets cal a revenue deposit R.

     Income Account += R

  2. Profit Account: A fixed percentage is transferred into the Profit account. A minimum profit percentage often depends on industry standards, but a common benchmark is 10% of revenue. For small businesses aiming to ensure profitability and sustainable growth, targeting 10-15% can be realistic.

    Comparatively, this profit margin should outpace the average returns of savings accounts (often below 1%) and be competitive with stock market returns, which historically average 7-10% annually. Aiming for a profit margin in this range provides stability while outperforming passive investment strategies. For 10% profit:

     let P = 0.1 * R
 Profit Account += P
 Income Account -= P

  3. Taxes Account: Set aside a percentage for taxes. To be safe, set aside the full VAT portion of the revenue plus 20.6% of your profit

     T = P * 0.206 + R * 0.25
 Tax Account += T
 Income Account -= T

  4. Operating Expenses Account: The remaining amount after profit and tax allocations should be transferred here to cover all necessary business expenses such as rent, salaries, including the owners salary, utilities, and other operational costs. If you've set aside a fixed percentage for profit and taxes, the rest will go into the operating expenses account:

    E = R - (T+P)
Operating Expenses Accont += E
Income Account -= E

Reflection Questions:

  • How much revenue do you need to cover taxes, operating expenses, and profit?
  • What percentage of income should go into each account?

Section 6: Profit First Discipline

Once your accounts are set up, the challenge is to maintain discipline by consistently making transfers. Here’s how:

  1. Regular Transfers: Revenue must be regularly split between the four accounts.
  2. Monitoring Accounts: Track account balances and ensure funds are being used according to your plan.
  3. Consistency: Make it a habit to move money according to set percentages every time revenue comes in. Better yet, automate it.

Reflection Questions:

  • How will you maintain discipline with your Profit First system?
  • What challenges might arise in maintaining profitability?

Conclusion of Module 2: Ensuring Profitability and Financial Health

By exploring your business through the airplane analogy, understanding the Business Hierarchy of Needs (BHN), and applying the Profit First system, you've gained foundational knowledge on managing cash flow effectively. This module has provided you with practical strategies to set aside profit, cover tax obligations, and manage operating expenses proactively-ensuring your business remains financially healthy and prepared for growth.

With your four core accounts established, you now have a financial framework that prioritizes profit and ensures stability. Regularly assessing and adhering to this structure will help your business stay on course, giving you control over your cash flow and fostering sustainable growth.

Remember, profitability isn't just about making money-it's about disciplined cash management, setting up processes that work for you, and always being prepared for future growth and unexpected challenges. By following these principles and adjusting as needed, your business will maintain the right financial balance to thrive.

In the next module, we’ll focus on identifying your profit drivers and product strategy, using the momentum from your financial foundation to build and optimize the parts of your business that contribute most to your revenue and growth.

Homework

  1. Set up 4 or 5 bank accounts

    • If possible give them name. If possible also hide the profit account from your normal views.
    • If you have an accountant managing your accounts make it so that only they see the profit account and the cash reserves account.
    • Set upp your skattekonto to pay out to your tax account.

  2. Refine Account Percentages with BHN Analysis:

    • Review your current revenue and assess your allocations for Income, Profit, Taxes, and Operating Expenses. Use the BHN framework to adjust percentages based on business needs, prioritizing sales or profit as necessary.
    • Income: 100% of all revenue goes here initially.
    • Profit: X% to Profit, focusing on debt and net profitability.
    • Taxes: Y% to cover tax liabilities.
    • Operating Expenses: Z% to maintain business operations.

  3. Start Allocating and Reflect on BHN Questions:

    • Begin transferring money into your accounts based on new allocations. Over the next month, analyze how this impacts your business and reflect on questions related to sales and profit needs, such as shareholder dividends, marketing effectiveness, and cash reserves.
    • Can you get your accountant to do this or can you set up automation within your bank?

  4. Answer the questions on sales needs

    • Are the sales of the business enough to support shareholder dividends in line with business valuation goals?
    • Are you searching for and collecting leads?
    • Are you closing the sales?
    • Are you able to deliver what you sell, and on time?
    • Are you being payed in time?

  5. Answer the questions on profit needs

    • Are you paying down debt faster than accumulating it?
    • Are your costs of goods/services impacting profitability?
    • How often do repeat customers buy from you?
    • Is your investment in employees, equipment, tools, or marketing yielding ROI?
    • Are you building an emergency fund sufficient for 3-6 months of expenses?

Completion Checklist

  • [ ] Set up four core bank accounts.
  • [ ] Determined percentage allocations using BHN analysis.
  • [ ] Completed first set of revenue transfers.
  • [ ] Assessed and documented impact on profitability, sales needs, and tax readiness.
  • [ ] Answered BHN questions related to:
    • [ ] Sales: Shareholder dividends, marketing, sales closing, delivery, and collections.
    • [ ] Profit: Debt reduction, net profitability, transaction frequency, leverage, and cash reserves.