EFP 148: Profit First – A Different Way To Look At Business Financials

A few weeks ago, Joe and I sat down to review financials and he showed me this “Profit First Assessment” he did and then started using all this terminology that was unfamiliar to me. I knew he had some framework he was working from, but I had no reference point.

Finally I got him to backtrack a bit and he told me about this book he’d read, Profit First: A Simple System to Transform Any Business from a Cash-Eating Monster to a Money-Making Machine

I was a little thrown off by the title (Sounded sketch) but quickly realized I’d better get on the same page if this book changed my business partner’s thinking.

The Profit First Book and Why It Can Help You

I downloaded the book on Audible and dug in to catch up. What I found was a simple concept that’d had amazing impacts on businesses for thousands of entrepreneurs.

I was still skeptical, though – I had to talk to this guy. Why not get him on the podcast to flesh out some of my questions!

In this episode, I sit down with Mike Michalowicz to dig into the philosophy, strategy, and tactics behind the Profit First methodology. Whether you’re new to the book or a fan, you’re going to want to check this episode out.

Also – want to win a free copy of the book? Leave us your best comment and you’ll have a chance to win one of three copies we’ll be giving away to listeners.

Check Out This Week’s Episode:

Direct Download – Right Click, Save As

Topics Discussed This Week:

• How does the Profit First formula work in real businesses?
• Profit First – Should you wait until your earnings are “significant”?
• Does Profit First allow for building war chests? How?
• Profit First on a portfolio of sites or each individual site/business?
• How do you go about implementing Profit First strategies on Day 1?

Mentions:

• Listing # 40357 Affiliate Site In The Health and Fitness Niche
• Mike Michalowicz @ Profit First
• Profit First Book by Mike Michalowicz
• Built To Sell
• Dropship Lifestyle
• The Pumpkin Plan Book by Mike Michalowicz
• Mike Michalowicz Podcast
• Toilet Paper Entrepreneur Book by Mike Michalowicz
• Hubspot
• Jon Haver did a follow up on Amazon Affiliate/FBA Business Strategy
• Mention on Ahrefs Blog

Spread the Love:

“As the business evolves and progresses you’ll evolve and progress financially” – Mike – Tweet This!

“When you less money it forces you to be more innovative than the rest of the industry” – Mike – Tweet This!

“Every second we allow this bad client to stay is taking us away from our best clients” – Mike – Tweet This!

Are you familiar with the Profit First methodology? Have you implemented this or something similar in your business? Let us know in the comments!

 

Justin:                   Welcome to The Empire Podcast, episode 148. We’ve often said on this show, “Scale first and profit later.” But is that really the best way to run your business? We sat down this week with Mike Michalowicz, the author of the book Profit First, to find out why he thinks we’re dead wrong about that approach. You can find the show notes and all links discussed in this episode at EmpireFlippers.com/ProfitFirst. All right, let’s do this.

Speaker 2:           Sick of listening to entrepreneurial advice from guys with day jobs? Want to hear about the real successes and failures that come with building an online empire? You are not alone. From San Diego to Tokyo, New York to Bangkok, join thousands of entrepreneurs and investors who are prioritizing wealth and personal freedom over the oppression of an office cubicle. Check out The Empire Podcast. And now, your hosts, Justin and Joe.

Justin:                   When I was a kid, my parents sat me down and gave me a bunch of little envelopes. I don’t know if they did this with you, Joe, your parents did this, but they gave me a bunch of little envelopes and they said, “Okay, here’s what we’re gonna do. This is your long term savings, this is your candy envelope, this is your toys envelope, and this is your tithing for church envelope.” So, they gave me all these different envelopes. And every time I got my allowance, the idea was to put, you know, four dollars in this envelope and three dollars in this envelope, and we actually wrote the percentages down on the envelopes. And I thought that was neat when I was seven, but I didn’t know that this is an actual business process you can use for your finances as an adult.

Joe:                        Yeah. You know, my parents never taught me that method, but I was a big believer in the pay yourself method first. So, something I’ve used for personal finance for a long time is, X percentage of any paycheck or any income I earn goes into my savings account no matter what. And then I’m left over with what I can spend on my necessities.

Justin:                   But we haven’t exactly done that with our business, right?

Joe:                        Right.

Justin:                   That’s not kind of the path that we took. And you read this book, it’s called Profit First. As I said, it’s by Mike Michalowicz, and you read it and this is all I heard, man. I heard you just going, “Ugh, we need to put more money in the profit. We need to put this away first.” And I was like, “What the hell is this guy talking about?” You started using jargon. You sounded like you joined a cult. And I was like, “What the hell is going on with this guy? I gotta find out what the deal is.” So, then you told me you read this book, and it kind of got you on this new way of thinking. I was like, “Shit, I gotta go read that book I think.”

Joe:                        Yeah. I mean, the biggest concept of the book is that revenue minus profit equals expenses. Instead of the normal revenue minus expenses equals profit, you’re taking the profit first. And that’s the simple concept of the book, but he gets into many more complex sort of ideas in an ordered way to fulfill that.

Justin:                   Yeah. And if you think about this, a bunch of the people we know, the entrepreneurs that we know and peers, they do the revenue minus expenses equals profit. And a lot of times, they don’t have much profit left over. And they put that off to, “Oh, I’m scaling the business,” or, “Oh, at scale, I’ll pull out some profit. It’ll be worth more.” But sometimes, that never materializes. And you and I know, Joe, sometimes businesses don’t work out. Sometimes they don’t go anywhere. So, at least with this approach, you get to take some of that profit in first, and you get to … it feels good. The business is working for you, right? And that’s one of the things he talks about. So, I think that’s kind of a neat idea.

One of my problems with it going into it is, well, when you’re so small that it almost doesn’t matter, there’s just not enough to take out. I mean, you’ve got to get it up to something that’s significant. So, I actually asked him about that in the interview. I also asked him about the problem of, isn’t it like to have a nice war chest? So, if you see your competitors, you can buy them out, or you see a big opportunity, you can jump on it ’cause you got the cash. I said, “What’s the deal with that?” So, we get into that as well. I thought that was pretty interesting. He’s got an interesting check on the financial health of your business that you can do, and we’re gonna link to that in the show notes if anyone wants to take a look.

Joe:                        Yeah. A lot of the math in this book is very simple, which is what really appealed to me about it. It doesn’t get overly complex, it doesn’t use a lot of accounting jargon or anything like that. You don’t have to be a master in accounting to figure this stuff out. It’s really easy, some basic spreadsheet, you can figure out your numbers and see where you’re at. And you can have a path to profitability very quickly if you kind of follow this model.

Justin:                   Yeah. If anyone’s listening to this podcast and they listen to the interview, they really like the guy, which they should, he’s awesome and fun interview guest. But if you dig it, we’re giving away three free copies of the book Profit First. We’ll give you an e-book, or you can download it on Audible, and we’re gonna give it to people who leave the best comments on this episode on EmpireFlippers.com. So, head out over to the site, check it out, leave a comment, and we’ll give you a chance to win a free e-book for the first three people that leave good comments. So, head on over there. Before we get into that though, buddy, let’s talk about the featured listening of the week. What do you got for us this week?

Joe:                        This week, we’re talking about listening 40357. It’s a share or sell affiliate site in the health and fitness niche. And one of the reasons why I really like this site is because we’re going into the time of year where the health and fitness niche is gonna be huge. Not only are people buying equipment over the holidays, but then you have the New Years resolution period. So, the seasonal bump is coming up, and a site like this could really benefit from that. This site in particular requires very, very little action. All it requires is some content to be updated every month. It’s making net profit just over $1500 a month, and we have it priced at about $35,000. It’s been very consistent over the past six months. It is relatively new, but it has shown some consistent growth and good numbers over the last three months, and I do think it will continue to show that over the good season that we’re going into.

Justin:                   Yeah. It’s making a little over $1500 in profit, it’s priced just over $35,000. The trendlines are good in terms of going up, so yeah, I think that’s pretty interesting. If anyone wants to check this out, again, it’s listening 40357, and we’ll link to it in the show notes.

Speaker 2:           Now for the heart of this week’s episode.

Justin:                   I’m really excited to be talking to Mike Michalowicz. He’s the author of Profit First, the simple system to transform any business from a cash eating monster to a money making machine. He’s also founded and sold two multimillion dollar companies, lost everything, and figured out a way to get it back. He’s also a sought after speaker on entrepreneurship. Mike, thanks so much for coming on the show, man. I appreciate it.

Mike:                    Aw man, this is awesome to be here, brother. Thanks for having me.

Justin:                   All right buddies, let’s talk profit first philosophy. Can you break it down for us in a 60 second, I don’t know soundbite, but can you give us kind of the basic idea behind profit first?

Mike:                    Yeah. So, I challenge the standard belief that’s out there that profit comes last. We actually use soft terms like, it’s the bottom line, it’s the year end, it’s the final take. But what comes last gets ignored. I mean, think about our own lives. If we ever say, “Oh, I want to put my health last,” no. Or, do you want to be the person who gets picked last for the team? No. It’s what comes first which is prioritized. What comes first is the most valuable.

So, what I suggest in the book, and I don’t just suggest it, I’ve lived this now for myself, and we’ve implemented it with countless companies. Is that if you put profit first, meaning when you get money into your business, you put it in the bank, immediately take a predetermined percentage as profit, now you’re putting profit first. And your business, as a result, will be far more profitable than it ever has been, because what comes first gets taken care of. What comes first gets noticed. What comes first gets done.

Justin:                   The idea is you’re taking a revenue minus profit, and whatever you have left over is expenses. And I hear that, right, and I’m like, “Oh my God. Every single dollar that comes in, I gotta split it up. I gotta put it in different accounts.” That’s a little freaky. And then you talk about batching. You say, “Twice a month, you’re gonna do this.” So, it’s not this crazy undertaking where every single dollar that comes in gets split up. This kind of reminds me, when I was a kid, my mom said, “Look, Justin. If you want to save, you need to put a little bit of money in this envelope for savings. You need to put a little bit of money in this envelope for tithing. You need to put a little bit of money over here for candy or whatever.” And so I had all my money that came in split up, and it seems very similar. Why do you think this works for people?

Mike:                    What Parkinson’s law states is that it’s human propensity to adjust our demand for something based upon its supply or availability. The classic example I love to use is toothpaste. If we have a brand new tube of toothpaste, we will use a long bead of toothpaste. We pour water on it to dampen it up, and the toothpaste falls in the sink, we’re like, “Screw that, it’s disgusting in there. I’m gonna get more toothpaste.” But when that tube is almost empty, our behavior changes radically. Now, we bend the toothpaste tube over the sink. We put as much pressure into it to squeeze toothpaste out. Now, one little drop of toothpaste on the toothbrush is adequate, and if it falls in the sink, we dive in and scoop it back out and use it.

Well, it’s true with money, too, is that if we have a full plate of money, all that money gets deposited into your business is available to run your business, we will find a way to use it lavishly, use it excessively. Conversely, like the toothpaste tube, if we intentionally reduce the amount of money available to operate our business, it forces innovation. We bend the toothpaste tube. We squeeze it, we approach it in a different way. So, it forces innovative thinking and frugal use. We use less of it to accomplish the same task. That’s why it works. And the principles your mom told you with the envelopes, that is the process. Allocate money in advance for its purposes, and then you’ll find a way to get it done. If you don’t allocate this money in advance, you’ll find a way, according to the Parkinson’s law, to use it all, in usually an ineffective way.

Justin:                   I like how you talk about entrepreneurs paying themselves first too, and you talk about, who are the most important employees in the business? And it’s very likely, especially if you have a five man, 10 man team, that you’re still pretty critical to the business. And not paying yourself is demotivating, you’re … you know, there is something psychological going on there if you’re not paying yourself enough, don’t you think?

Mike:                    Oh my gosh, yeah. I do this to live audiences. I just did a tour of Canada, I spoke with different groups. Cumulatively, maybe it was about 1000 people over five speaking engagements. And I would ask the audience, you know, 200 people or so in the audience, “Who here has employees?” For these people I would talking with, most of them did. They raised their hands, and I would just randomly pick people out of the audience, say, “What’s your name?” The guy says, “I’m Joe.” I would say, “What’s the name of your best employee?” “Oh, Susan,” or whatever. Next, ask the next person. “What’s your name?” “My name is Cindy.” “Who’s your best employee?” “Oh, it’s Mark.”

No one ever named themselves. And then I point to them and I say, “I don’t know you, I don’t know your business. But I do know this, you’re already lying to me. The best employee is you.” ‘Cause think about it, the owner sacrifices their family time, sacrifices vacation. They work day in day out, and they do all this stuff for no pay. Would you really go to another employee of yours, your quote unquote best employee, and say, “Hey, could you keep working and work harder? And by the way, I’m gonna stop paying you”? No, no. But we do it to ourselves. And what happens over time is we start to resent our business. It becomes this perpetual sacrifice, and then we start to loathe or dislike our business. And that’s where the effectiveness, the drive, the energy dissipates and goes away. So, we need to start treating ourselves like the best employee that we truly are, and reserve money to pay ourselves in advance.

Justin:                   I mean, it is true though, you know, we have our buddies over at Tropical MBA, and they talk about the thousand day rule, right? The thousand day principle. And it takes time to kind of get to the point where your business is more stable and more secure, and there is a ton of hustle. There is some sacrifice that goes into those first three years, but I think what you’re arguing is that you don’t need to be a martyr for your business, right? You shouldn’t not pay yourself. And you think that people lean too far towards that. They’re like, “I need to suffer for my business. This is the way that it is.” Is that a general problem? Is that why you roll it back a couple of notches, to get people to remember themselves?

Mike:                    No, that’s right, ’cause people treat it like an on and off switch. “I’m not being paid, not being paid, off, off, off. And then one day, I’m gonna flip it on, and I’m gonna make gobs of money.” The reality is, it’s not an on and off switch, it’s a faucet. I’m not saying take more money than the business can bear, take a predetermined percentage.

So, if your company has say a low dollar revenue for the first year, maybe it’s $50,000 in revenue, I’m not saying take $50,000, I’m saying take 10% of that perhaps. Now, you take $5000. Next year, the company does $100,000, you continue at 10%, but now your compensation is $10,000 as oppose to $5000. So, if you take a percentage based draw from the income of the business, you’ll always have something that’s in the proper ratio. And over time, as the business evolves and progresses, you’ll evolve and progress financially.

Justin:                   So, to explain this to some of our audience in terms of profit first, there is a profit first assessment that you can take, and it gives you different percentages at different revenue amounts. And you talk about real revenue, so e-commerce guy is doing $10 million a year. That’s not your real revenue, you need to break that down and get rid of cost of goods and all that. So, it does give you different percentages. So, at lower percentages you’re taking more in owners pay, and then larger percentages, you’re taking more in profit and less in owners pay because you’re salary is not gonna be a large percentage of the revenue for a large company. So, that’s interesting, I like that.

When people are implementing this Profit First philosophy, let’s say they do the assessment and they’re thinking about getting started, what are the difficulties in kind of getting started? Are people like, “Oh, that seems to simple”? Or is it, “There’s no way I can get to those levels”? What are some of the frustrations?

Mike:                    Yeah. One of the most common things is, probably first is a bank balance based system, meaning you don’t have to look at your PNL or your income statement or your cashflow, or any of that stuff. You log in your bank account to see your balances for different purposes. You basically set up those different envelopes. Now, they key is this, you need to set up multiple accounts. So, instead of having one or two bank accounts, you may have like five, six, or seven bank accounts. And I don’t really know the reason why, but this trips people up. I think because it’s not common. How often do you go to your bank and say, “I need six or seven new checking accounts”? Your banker will look at you kind of half cockeyed going, “What are you doing?”

So, people resist it just because it’s a little bit different. There’s no headache, it’s easy to do, and if you’re with the right bank, there won’t be any bank fees associated with it. But still, people are resistant to it. The other thing that people trip up on is they go too intense too fast. I call it taking a frozen mug out of the freezer and sticking it in a boiling hot oven. It’s gonna shatter that glass, too fast of an adjustment. Too many people say, “Ah, I love the Profit First system. I’m gonna start allocating big numbers toward profit. I’m gonna allocate 20% of all inbound revenue to profit even though I’ve never been profitable before. I’m gonna take like 70% and allocate it to myself even though I barely made any money before, because I want to treat myself well.”

Well, now 90% of your money is allocated to profit and yourself as a salary, there’s 10% left to run the business. That is such an abrupt adjustment, it can shatter a business. Now, I’m not saying your business can’t do it. Some businesses actually hit those numbers. But that takes a lot of time, a lot of effort, and a lot of really, really innovative thinking on how you can increase your margin so much. So, the key is, don’t go start off fast. Start off slow, lower the bar, don’t raise the bar. If you’ve never been profitable, start off by allocating one percent maybe two percent. If you’ve never taken an income that’s been substantial, start off at five or six percent of the revenue to your income. And then every quarter, slowly ratchet this up. Then, you’ll get to the numbers you want to without shattering the glass of your business.

Justin:                   Yeah. That sounds really small, one percent, two percent, but it’s really about the habits, right? If you can get into the habit of allocating some percentage of the profit and do it regularly, then you can bump it over time. And you talk about that a bit in the book. Let me ask you, Mike, a lot of our customers have websites, right? They have anything from a couple of websites that earn money to dozens or even hundreds of websites, and they have a whole team of people running them. And these websites make money online. Now, should they follow a Profit First approach on each individual website or online business, or can you kind of group them together? Let’s say I have an AdSense site making $2000 a month, and I have an Amazon site making $12,000 a month. Do I have to treat those separately in Profit First and have a gazillion bank accounts? Or can I kind of put them together?

Mike:                    Actually, it’s best to do it separately. And you know what? Listen, at least do the analysis separately. Maybe when it comes to the execution, do it collectively. Here’s a story that kind of drives this home. There is an avionics company that I was meeting with, they were due about $13 million in cumulative revenue, but they got multiple divisions. One is maintenance and repair, another one is Learjet rental, so if you want to fly around in a jet, they rented it out, and so forth. They said, “You know, the best company we have here is our maintenance. It brings in new airplanes all the time, and when an airplane is not in use because it’s being maintained, those owners usually rent from us. It’s the cash cow.” And they were doing profit first cumulatively and they didn’t really know what the cash cow was, but they just assumed that.

We broke out each business as its own standalone and ran an assessment on it, and it became very clear when we ran these percentages against it, the worst thing they were doing was maintenance. It was the leech of the company, it sucked out all the blood.

Justin:                   Oh, wow.

Mike:                    And yeah. Since they couldn’t see that, they were like, “Well, look at all the benefits.” But once they realized it was sucking out all the blood of the company, they very quickly, I mean over six months, but they wound it down. And now, the business is more profitable than ever. So, if you own multiple businesses, run at least an assessment on each run. Run these predetermined percentages and see which ones are making money, which ones aren’t. The old 80/20 rule usually plays out here. 20% of your businesses are yielding 80% of the profitability. By assessing them through this profit first system, you’ll determine which one is which. Then when it comes to running them, yeah, maybe you can do it cumulatively, but I’d go back every quarter or so, every 90 days, and just reassess each business as a standalone entity.

Justin:                   Yeah, that makes sense. Okay, so you’re gonna assess each business differently, but if you’ve got a bunch of small earners, you may put them all into the same pile in terms of how you’re actually playing it out.

Mike:                    Yeah.

Justin:                   Just ’cause it would be silly for a $500 a month earner to have a different bank account. It’s so small, right? But yeah, okay.

Mike:                    Totally.

Justin:                   So, you’re putting it together, but you want to assess them. And I think that’s really interesting because we have a couple of different parts to our business. We actually paired down, so we have two right now. So, I would want to know if one was sucking out the profit from the other one, and that does happen in business. Sometimes, you are funding a portion of your business to grow or do something like that. So, that can be scary especially if you get stuck in that trap for a while and you don’t even realize it, right?

Mike:                    Yeah. It happens way more than you’d think, and think about how our mind operates. We want to see what we want to see. So, we want to believe that all of our businesses are doing well, and when the numbers are clumped together, you’re blind to the fact that maybe one is doing poorly. And we don’t want anything to do poorly, so we just say, “Oh yeah, it’s doing well and the numbers support it because they’re clumped together.” So, breaking it out, it’s kind of like the ice bucket challenge. Sometimes, it’s a cold bucket of water in your face. But ironically, if you have a losing proposition, by getting rid of that, inevitably your profit jumps because you’re not losing money there. But the available time you have now to concentrate on what’s working and amplify that is such a significant benefit. It behooves you for sure to drop the losers.

Justin:                   Yeah, I could see that definitely being important for large companies, too. ‘Cause a lot of times you have self contained or encapsulated mini businesses inside of your larger organization, and so making sure each one of those is profitable on their own. And kind of testing them and checking them individually seems to make sense. I’d want to know if this sales team, my outside sales team, was doing better and I compare them to my BDB or whatever. So yeah, that’s interesting.

Mike, so Joe and I were arguing a little bit about this. Joe is my business partner and the podcast cohost. ‘Cause we were talking about kind of our audience, right? So, let’s say I have a guy that’s building this Amazon site. It’s an Amazon affiliate sight, or let’s say a drop shipping site or something where they’re selling e-commerce. And they get to the point where they’re doing $600, $700 a month. Especially for an e-commerce site, but they need to reinvest in inventory, they need to reinvest in the business and advertising, and I say, “Look, you need to keep doing that until it’s substantial, right? Until it makes some amount of money that makes sense.” And Joe is like, “No, no, no, no, no. You should do profit first. Even if you’re making $30 a month, it’s a better approach.” And I hear what he’s saying, but it seems like it would hurt growth. It seems to be better to double down early on until you get to where it’s substantial, and then implement.

Mike:                    Yeah, and you would think at face value that’s totally correct, but I hate to say this, I’m gonna side with Joe here. Not from … you never do that to a host by the way. Now-

Justin:                   How dare you? How dare you, Mike?

Mike:                    This show is done. So, I am siding with Joe not because I feel that way, it’s because I’m experiencing that way. Here’s what’s fascinating. The less money that’s available to put back into our business, the more it forces innovation. Now, I own multiple companies, and I’ve consulted indirectly hundreds. We have a team of, we call them profit first professionals, that help people with profit first, and we give these feedback. Well, I’m a co-owner and manufacturer, I’ll give you this one as an example. We implement profit first, and we need to buy equipment. We need specifically to buy a molding press to help us mold leather, and these are heavy presses you get, and they cost tens of thousands of dollars. It’s the only way in the industry, by the way, to mold leather, so we thought.

Well, when we did profit first, there wasn’t enough money flowing through to buy a molding press. And we’re like, “This is stupid. Either we gotta shut down the business because we can’t do it, or we gotta get rid of profit first altogether.” Or, we found a third alternative. We said, “Well, let’s see if we can work with what we have.” You see, when you give yourself less, you must reverse engineer how to accomplish the result you want with the less money you have. So, we just said one day, “We’re gonna go to Home Depot and see what we can buy with our stuff, what we can afford now that this is the only stuff that’s available.”

I’m not gonna tell you what we found, because it’s now proprietary, it’s the way we manufacture. But I will tell you what didn’t work, this gives you a hint. We were looking around, we found microwave ovens. So, we bought, you know they’re $99, we buy a microwave oven, we start testing microwaving leather. Which, by the way, is not a good way to mold leather, but it was an indicator on a new technique for molding leather. We’ve discovered a way of heating leather in a special format that allows it to be more moldable, more pliable, and doesn’t require a press. As a result, we can accomplish in fact a better mold on leather than a leather molding press can, and we can do it for a few hundred dollars, where our competitors who aren’t onto this are still buying a $10,000 machine.

The moral of the story is this. When you give yourself less money to get stuff done, don’t cross your arms and say, “I can’t do it.” Because what you’re saying that you can’t do is the only way to do what the industry discovered. What I’m saying is, when you have less money it forces you to be more innovative than the rest of the industry. It gives you the leg up. You have to find a way to get it done with less money, and when you do find it, it may take time, it may take effort. When you do find it, you become the industry innovator and you dominate the industry. The biggest growth comes out of innovation.

Justin:                   And that gives you a competitive advantage and helps you boost margins, at least in the short term when your competitors are goofing off and don’t see what you’re doing, right? So, you can suck out a bit more profit maybe during that time, until they catch on and start to follow you, right?

Mike:                    Yeah, money lets us follow the obvious path. And we use soft terms, plow backs, reinvest, push backs. All very soft terms for saying, “I’m not willing to strap myself to be innovative. I’m just gonna do the obvious thing that everyone else is doing.” When that money is off the table, it’s painful, it’s not easy, but that’s what innovative companies do, and you have to find a new way.

Justin:                   So, one of the things I love about Profit First, and Joe and I are following this now. He read the book first, was a big fan. And I was telling you before the show, this happens sometimes in business partnerships. I did this with Built to Sell, right?

Mike:                    Oh yeah, great book.

Justin:                   I read this book and I was like, “Joe, you gotta go read this.” And he was like, “All right man,” finally. And then he was like, “Dude, that was really good.” And so he did the same thing with Profit First, and he started talking in profit first terminology. And I was like, “Why is he dorking out on this? What the hell is this book?” And so I went and listened to it and I was like, “Wow, this is really interesting.” And one of the things that really struck me was just your general idea that the business serves you, right? And often, I’ve felt this way and I know entrepreneurs have felt this way, there are times where you do feel like you’re a slave to your business, right? You know there’s a larger goal, but you are just dog tired from working for the business, right? And so the business never does anything for you.

So, the idea of taking distributions, right? Taking profit distributions over time and letting the business pay you was attractive. We actually took our first distribution here recently and I was like, “Oh, that’s a nice payday.”

Mike:                    Cha-ching.

Justin:                   Yeah, not too shabby. One of the things though, that I question, look, I love it. But there’s some value in having a war chest. Above and beyond three months expenses, which you mention, in having the ability to act quickly when something comes along, let’s say an acquisition opportunity or some other potential thing. It’s good to have that cash there in a war chest. How do you allocate for a war chest if that’s important in your business?

Mike:                    Yeah. So, you can allocate money. Now, I give some guidance on what I think. Basically, when it comes to distributions … well, I want to answer two things, actually. One, your question directly. But also, I think it was inferred, the power of a quarterly profit distribution, most small business don’t do anything. We do a year end, we see if there’s any money left, which there rarely is ’cause we put profit last. And then we go, “Oh well, next year I’ll make it.” And we keep putting it off. That builds a negative relationship with our company, just behaviorally speaking.

Justin:                   Yeah.

Mike:                    The relationship is negative. The benefit of a quarterly distribution, yeah, there’s some money there, which is nice. But it starts building confidence. Your first take might not be huge, but you’re like, “Hey, I got money from my business. This is exclusively for me.” And then it starts reinforcing the behavior of profitability. That’s why we do the quarterly distribution, and over time that can become very substantial. Now, when it comes to the war chest, I do subscribe to three months of operating expenses. Meaning, if not a singly penny came into your business, can you run for three months? Now, here’s the reality.

Most businesses don’t stop cold turkey. Business just doesn’t stop instantly, it can dry up and slow down, but if it just dries up and slows down, maybe you’re getting half the business you got. Three months of expense will support you for six months. So, a free month reserve, cold turkey reserve, usually covers six months to a year of operating. And if you can’t recover in six months or a year, you have something much, much greater going on, and have to do a much more fundamental shift.

Now, the last thing is, profit first is a percentage based system. It’s not perfect for everyone. Other folks may say, “I just feel comfortable with more reserve.” That manufacturing company I told you with, we have a year’s reserve because my partner there, Paul, he’s just, “Dude, I only feel safe if there’s a boatload of money backing me up.” So, that’s how he is. We take a quarterly profit, but we’ve decided and agreed to scale it back. We set up an account, we call it the vault, that has now a year’s operating expenses in there. This business, an earthquake could knock this thing down, we’d keep operating for at least a year. So, you can throttle it based upon what your kind of risk aversion is.

Justin:                   When you talk about the three months saving, because our company is growing, for example, right? So, if I look back at [inaudible 00:26:43] 12 months, I have one monthly expense. But if I look forward, I know that our expenses are gonna go up. Should I save three months based on where we are today? Where we think we’re gonna be in six months? Where we were six months ago?

Mike:                    No, profit first is a what have you done for me lately kind of system. So, where do you stand today? We as entrepreneurs are very bad at projecting our future, and very bad at projecting anything that’s beyond a year out.

Justin:                   Yeah.

Mike:                    Usually, we’re way overoptimistic. So, when we launch our business, we’re like, “Ah, we’ll probably do a million in a year.” And like five years in, we’re like, “God, I can’t even do $200,000. What’s going on with me?” And that’s the reality. So, profit first is all about where do you stand today? And prepare for today, ’cause that’s the only thing that we can quantify. Now, the nice thing is dynamics. So, six months from now you do hit, your numbers are better, profit first because it’s a percentage based system, adjust with is on a live basis. Conversely, if you don’t hit the numbers and it’s a little slower, you’re not booking away all that money that you really can’t afford at that point. Because again, it’s a percentage based system, it adjusts based upon what the reality is in the moment.

Justin:                   Yeah. So, as you go along and your expenses continue to go up, you realize, oh, I need to save a little bit more. My distributions are gonna be a little bit less ’cause I need to have more in my cover my ass chest, basically.

Mike:                    Yeah, but if the revenue goes up, your percentage, say the percentage stays the same, the amount, the actual dollar amount, goes up for your distributions.

Justin:                   Yeah.

Mike:                    Which also, in turn, a dollar amount for your reserves go up in exchange, in correlation with that.

Justin:                   Cool. You talked in your book about Parkinson’s law, which I loved. Work expands just to fill the time available for its completion. We have a buddy that does an entrepreneurial event in Thailand every year, this is his second year that he did it, and it’s called Drop Shift Lifestyle. And he put it on, and the first year, he gave his team, a couple of people, he gave them a couple of weeks to kind of put this event together for 100 people. And so they were rushing around and they were getting everything done, and they got it done, and there were some mistakes or whatever. The next year, he gives them like three months, and it’s probably more screwed up than the first year. They had more mistakes, and he gave them three months to get it done. I just thought it was a really amazing example of this in action, right? And it seems, it really struck me as true.

You argue, you know, that’s one of the reasons that we need to separate our profit, right? Otherwise, we’re gonna suck it all up. It’s gonna go into my Facebook ads, it’s gonna go into whatever business toy I want to buy that month.

Mike:                    Right.

Justin:                   Which happens, right? We get all, “Oh, this will be a shiny new toy, I want to play with that.”

Mike:                    I deserve it, yeah.

Justin:                   Yeah. This forces us to be stuck working inside the confines of dollar amounts we have available. You can do this with other things tough too, right? You can do this with your time. So, if I have a three week project, I’m gonna say, “Ah, I’m gonna make this four days. I’m gonna really cut it off so that I can ship.”

Mike:                    Yep. Yeah, so we actually do it with our own employees. So, we have five folks here working on profit first. Profit First Professionals, our organization around it, all part timers. And so on average, the average part timer here works about four or five hour days, but they’re giving eight hours of work, and that’s the big secret. They don’t know it’s eight hours of work. We say, “This is the work you need to get done. Please get it done during today.” And they all nail it. And it’s not like these folks are superhuman. By the way, they kind of are ’cause they’re awesome. But nonetheless, they’re given a confined amount of time, they get the work done.

So, you can do this with all aspects of your business. The biggest one, as entrepreneurs, is really for us is around the money, though. When we see money available, we always have a reason that we can use it. We always have a justification. Oh, I need to facilitate growth. Oh, I need that fancy car because listen, if I pull up to a meeting in a crappy car people are gonna think less of me. It’s a sales tool. There’s always a justification, and it’s always a legit justification, and that’s the problem. So, we always find a way to spend the money. And that’s why money has gotta be removed off the table, and with your own people, reduce the time available to do things. They’ll actually get more done in a shorter amount of time. It plays out over and over and over again.

Justin:                   So, if I’m going through this assessment, Mike, and I’m looking at it and I’m going, “Okay, well I don’t have much profit at all.” Let’s say I have two percent or three percent I’m gonna assign to profit. It’s very, very small, and I’m looking for cuts. I mean, one of the first things I’m gonna do is I’m gonna cut expenses. That’s one of the ways I can do it, obviously boost revenue as well. I want to avoid things like cutting marketing costs that are delivering an ROI, right? That’s not a good idea. That’s gonna hurt me.

Mike:                    Right.

Justin:                   Maybe, you talk about if I’m gonna cut costs, I can look at negotiating some of my monthly fees and cutting some of the things that you used to use six months ago and don’t use. What’s the best approach? I mean, you want to avoid cutting, well, you want to avoid cutting good people in your organization, what else? Is there anything in particular you’d avoid?

Mike:                    Yeah. So, if you have multiple people in your organization … well, actually let me rewind. Start off with the Pareto principle. The Pareto principle is the 80/20 rule, and the basic rule is that 20% of a thing, your people, 20% of your clients, whatever, yield 80% of the benefit. So, 20% of your staff are the A players, the most productive. 20% of your clients yield 80% of your revenue. So, what you do is an evaluation of all the elements of your business and say, “What’s the pieces that are bringing the most?” 20% of your expenditures, your other costs, are yielding 80% of the benefit to the clients. Well, you can cut the 80% that’s not bringing those benefits.

So, you look at all those things, employees too. Who’s the top 20%? Protect them. Actually, maybe even pay them more to retain them. But you probably have a few employees at the very bottom that are not the producers. Increase your margins for sure. Whatever you’re selling, you can increase revenue which means sell more, but you can also increase the margin. That’s a huge profit opportunity. But one thing that many people don’t think of and at first blush, it sounds like this is crazy. If you want to increase your profitability, fire clients. And people hear that and they’re like, “Hold on, hold on, hold on. I want to increase profit and you’re saying get rid of people that pay me money? That’s total bull.”

But here’s the reality. 20% of your clients, if you follow the Pareto principle, yield 80% of your profitability, which also means there’s a very low action on your clients, the lower 10% that are actually costing you money. And there’s been tons of analyses, there’s a company called Strategex in Chicago that ran a really in-depth analysis around this, and found this to be a consistent paradigm for most businesses. Most businesses, our lowest 10% actually cost us to keep them. Why? They’re paying us very little, we’re generating very little revenue from them, but they suck up our time. They’re a distraction. They’re never satisfied. They require rework over and over again. They pay late. All these things pile up. If we simply remove those clients, yes, that little bit of revenue generated is gone, but all those expenses were incurring, redoing work and all that stuff, that all goes away. Those resources can now be redirected toward the profitable clients. So, it’s ironic, but just by firing a couple bad clients is an instant booster in profit for many companies.

Justin:                   Oh God, Mike. I am 100% with you. So, we learned this the hard way. When we had our outsourcers company, we would just hire anyone. We would take on any client, right? ‘Cause we needed the business and we were like, “How do you turn down money?” And so we’d just take on any client. Clients that we thought we could work with, “Oh, it seems like it’ll work.” And it was the worst. We ended up with some horrible clients, clients that we couldn’t deliver from that were just too demanding. And we learned over time that wow, by saying no to clients, saying no to the wrong clients, you save yourself the time. They’re not gonna cancel, they’re not as likely to cancel. They’re gonna provide a higher lifetime value. It was amazing. It’s a really tough lesson to learn, and you tell people that though, and they’re like, “Yeah, I don’t know, but I need the money.” No, you-

Mike:                    Yeah, but my business is unique. You know, my-

Justin:                   Yeah, yeah.

Mike:                    I hear it over and over again.

Justin:                   My business is different.

Mike:                    I believe this so emphatically, and this is gonna sound, cheesy plug. But I believe this so emphatically, I wrote an entire book to surround this principle, so maybe you and John can dig into this one. It’s called The Pumpkin Plan. But basically, what I studied was, I studied pumpkin farmers and found these guys that grow colossal pumpkins. What they do to do it, the biggest, most important thing, is they cut other pumpkins off the vine.

And I said, “Well, why do you do this?” And he said, “Every second I allow another pumpkin to grow, a little pumpkin, it’s taking nutrients, water, energy, time, away from the colossal pumpkin.” And that was kind of the aha moment to me. Every second we allow these little clients to grow that are struggling, they’re distractions, not only are we trying to cater to them and not make money, it’s taking us away from our best clients.

Justin:                   Yeah.

Mike:                    It’s killing us.

Justin:                   Yeah. We have a no asshole rule at Empire Flippers. Generally, every time we break this rule, Mike, we end up screwed. Every time we’re like, “This guy’s an asshole. We shouldn’t be working with him.” And it turns out, we shouldn’t have been working with him. So, it’s just, there’s a fit for your business. I think even a cultural fit for your customers, and some people just aren’t in the box. And I think that they cause us more problems than they’re worth. And you know, obviously it’s the same thing with employees and contractors and we do that, but with customers as well, there has to be I think a cultural fit. So, yeah man, no asshole rule. We don’t do business with assholes.

Mike:                    We have the same rule, but we call it no dicks allowed. Same thing.

Justin:                   Yeah, yeah. I know some people charge a tax, what do you think about that? Have you charged a tax to people that are a hassle or whatever? I just think they end up sucking up more of your time. They want more for that.

Mike:                    Yeah, I haven’t found that. I’ve done that where I elevate the price for the people I don’t want to work with. And when I say no dicks or no assholes, I don’t mean they’re necessarily bad people, I just mean they’re bad clients.

Justin:                   Yeah.

Mike:                    It’s a bad fit, right? I will elevate the price, and I’ve found two things that happen. The price shoppers, which are the worst clients, they go away instantly, and that’s what I wanted. If they’re gonna shop price with me, I don’t want to be involved anyway. Some people resist it and go away just ’cause they’re like, “That’s not fair to me.” But a few people actually step up their game. If you say, “You know what? I’m gonna be more committed. I’m gonna work more in this relationship.” Now, here’s why. The more money that people pay me, the more, I call it appreciation points. The more they’re invested in the success, the more they appreciate my value. Just like if I pay you $100, well, $100. But if I pay you $10,000 for something, I’m paying attention. That’s real, real money to me. So, the more people pay you, the more they value and appreciate you.

Justin:                   That makes sense, Mike. Quick question. I talked to you, we talked to one of your profit first kind of advisors. We called them and said, “Oh, maybe we can talk to someone about this. Maybe we can get a bookkeeper.” And that’s still something we’re looking at. One of the questions I have though, is that the guy we just spoke to mentioned, I think it was Amazon FBA businesses. And we were talking about it briefly and he says, “Yeah.” He’s like, “I know bookkeepers that won’t even take on FBA businesses.” These are businesses that require heavy inventory. You basically stock and store that inventory with Amazon. Are you at all familiar with that and why that might be the case? Are they difficult to work with in terms of bookkeeping and their numbers are off? Do you have any idea?

Mike:                    No. Why Amazon won’t take those clients on?

Justin:                   No, no.

Mike:                    Oh.

Justin:                   Why it wasn’t a good fit for some of the profit first bookkeepers.

Mike:                    Oh, yeah. So, we have a mix of profit first bookkeepers, and they all are being trained in a specialized vertical. So, if it’s something outside their scope, they’ll often say, “Listen, I’m not perfect for you.” We call it the written method, or riches in the niches. And we believe this is important not just to our members, but to all businesses. If you want to grow successfully and be very profitable, you have to have a niche focus. Why? First of all, that community becomes aware of you ’cause you’re always circulating in that community. But more importantly on the profitability side is that you start building efficiencies. You understand the client’s challenges and problems before they’re even aware of them, and you can solve them proactively. And the solution becomes repetitive, so you can systematize and [inaudible 00:37:43] it, and therefore dictate a premium. So, I don’t know who you’re talking about specifically, but I suspect they’re going through the written method. I hope they were very courteous about turning down [crosstalk 00:37:52].

Justin:                   They were. No, no, of course.

Mike:                    Yeah.

Justin:                   No problem.

Mike:                    Yeah. I have someone else that can help you out though.

Justin:                   Yeah, yeah, yeah.

Mike:                    But I specialize in e-commerce, so …

Justin:                   Cool, all right. By the way Mike, I just wanted to thank you for coming on the show. I mean, if anyone hasn’t checked out your site by the way, Mike Michalowicz, it is funny as shit. I was digging through all of your little carrots, your little, what they call them?

Mike:                    Yeah.

Justin:                   Easter eggs. Really funny.

Mike:                    Easter eggs.

Justin:                   Pronouncing your name, I’m sure I’ve donked it up at least once in this interview. But they’ve got a bunch of mispronunciations of your name, and your site is funny. Your podcast is hilarious. I’m gonna link to that in the show notes, and I’ve listened to probably three or four episodes now. And yeah dude, people need to go check that out. You’ve got some really good stuff over there. Is there anything I should’ve asked you about Profit First in terms of the book, or your other books, Toilet Paper Entrepreneur or Pumpkin Plan that I didn’t bring up here, you think?

Mike:                    No, I mean what a thorough interview. I think we nailed it all. I will share, actually, one final thought around profit first. If you’re inspired to do it, here’s what I encourage you to do. We touched on lowering the bar earlier. That’s the key to getting started. Yes, please read the book, please dig into it, please talk to a profit first professional. But before you even do any of that stuff, here’s the way to lower the bar the most. I’d encourage everyone that’s listening right now, go to your bank today. Set up just one new checking account, and change the name, the nickname, to the word profit. Start allocating just one percent of your revenue to that profit account. Which means if a $1000 deposit comes in, literally it’s $10 you move over to this account.

But here’s the power. Just by setting that up, you still gotta run your business off the $999 you have, and you’ll do just fine. But you’ll start appreciating the impact it has when you start allocating money to profit first, to this profit account. It starts accumulating. It’ll start winning over your confidence. Then as you move along, you can ramp up the percentages to have a real impact on your wallet.

Justin:                   Awesome, Mike. Well, thanks so much for coming on. If anyone wants to check it out, MikeMichalowicz.com. I’ll put a link in the show notes. Thanks man, appreciate it.

Mike:                    Thank you.

Speaker 2:           You’ve been listening to The Empire Podcast. Now, some news and updates.

Justin:                   All right Joe, let’s get into some news and updates. First up, we completed our quarterly strategy meeting, which we actually hadn’t done for a while. We had our whole team down here in Thailand, and we were able to sit at the table. It’s basically an all day session where we talk about the previous quarter and we look at next quarter. And because we’re heading up on the end of the year here, we actually did some of our goal planning for 2016. And we’re pretty aggressive, man. I think we’ve got a lot of work left to do if we want to hit those goals.

Joe:                        We have a lot of work next year, for sure. I mean, I think we’re gonna hit our goals this year, but we said the same thing about 2015 in 2014. We were a little worried about it and it wound up working out. So, I think as long as your goals are a little bit of a stretch, that’s a good thing ’cause it gets you creative and try to make sure that those goals happen.

Justin:                   Yeah, it was nice. One of the things we did this time with our meetup, we did a month long kind of work-cation where we got our management team together. What we did this time is we invited a bunch of contractors. And so we had a bunch of contractors hanging out with us, working with us. We had a designer, a developer, our content girl. And actually, we ended up with a new hire out of it. We have a guy we know named [Corin 00:40:54], and he came down with his wife and hung out with us for a bit. We were talking about what he was up to, and he had a business that he was still working on, but it was not taking up much of his time. We said, “Look, why don’t you join the team? Why don’t you work with us?” So, we did this kind of half ass thing with him where he was kind of doing some contract work with us, and kind of on the team. And we ended up saying, “This is ridiculous. Let’s just bring him onboard.”

Joe:                        Yeah. First of all, I think bringing the contractors down and having them work directly with us during this work-cation was a great idea. I want to do it next time again. It’s so nice to have them in the same room, even if we don’t have them 100% of the time, which is the developer, we had to share with his other clients and stuff. It’s still great to have them right across the table and get things done kind of quickly. So, that was awesome. And yes, welcome aboard [Corin 00:41:39]. Good to have another sales guy in the house, and he’s gonna be helping us out, hitting those goals in 2016.

Justin:                   Yeah man. Next up, we’ve got a development project that you’ve been working on. So, it’s kind of we’re right at the start of this. We’ve got quite a bit of work to do to knock this out, but I like the idea. We’re pretty far from actually having it done, but I like the idea. Tell us about it a little bit.

Joe:                        Well, yeah. So, the biggest thing is I think we decided that we have to invest in the technology of Empire Flippers. We have to introduce a little more automation into the system if we want to hit our goals in 2016 with the same amount of people that we have. And that’s good for buyers, it’s good for sellers, and it’s good for our team. So, the thing that we’re trying to introduce is something called the deal center, which will replace a lot of the communication barriers that we have with Zendesk and stuff like that. It’ll really be an all encompassing piece of technology where buyers and sellers will be able to communicate directly on our own platform.

Justin:                   Yeah. What I like about this, too, is that not only do some automation, but it also just gets our customers the stuff they want faster. So, a depositor, for example, can pay the deposit and will get an immediate reply, right? So, they’re gonna get all the information immediately right in their inbox. They don’t have to wait for one of our teammates to put it together. And that’s especially important on Mondays when we get just a ton of deposits, we get a ton of people looking at the sites ’cause we send the email out. And our team gets a little overloaded, it can take a few hours, even up to 12, 24 hours in some cases for them to get the information out. Which is not ideal, right?

Joe:                        Yeah. I think the cool thing is is that the deal [inaudible 00:43:06] is a very ambitious project, but we can introduce it in pieces. And the piece that you were talking about, the automated deposit piece, is something that I think we can do before the end of the year and have introduced as part of a new checkout page on Empire Flippers where people will be able to get away from the ultra cart and doing all of the deposit right now, and get an automated response from our system with everything that they’ve done as long as their payment goes through successfully.

Justin:                   Yeah. A lot of news and updates. Last bit is we actually signed up for HubSpot. We spent some money, baby. This thing is not cheap. We went with HubSpot Enterprise, and it is a beast, but the idea is to replace Entreport. We don’t really use Entreport as well as we’d like. Our sales guys, I.E. Joe and Mike and now [Corin 00:43:50], they’ll use it. So, the problem is, all of our marketing, we don’t know how successful it is in terms of the channels and where all the deals are going. So, we’ve taken a look at HubSpot, we’ve been using the CRM and been playing with the CRM a bit, and we just decided to pull the trigger. It’s a pretty expensive piece of software, but I think that it will help get us to the next level and will be good for us for quite a while. Eventually, we may need to introduce Salesforce to replace the CRM piece, but in terms of marketing automation, I think this will be really helpful.

Joe:                        Yeah. I love this, I think it’s a good idea. I think, again, this goes with the idea and the goal of investing more in our technology. Even though it’s not our own homegrown technology, it is a piece of technology that we need in order to work better. Because sorry Entreport, but you just weren’t cutting it. There’s just a lot of problems with that software.

Justin:                   All right man, let’s do some listener shouts, also known as the indulgent ego boosting social proof segment. Up first, I got a message on Twitter from Dylan Robertson said, “Empire Flippers is an amazing podcast for anyone with an online business. These guys always keep it fresh and bring tons of value.” Thanks so much Dylan, appreciate it. We also got a message, a question actually, from Quirky. Quirky says, “Do you deal with the part of a sale of a company with a website so that you still own a share in the company?” I actually replied to Quirky. I said, “Look, we will, but you have to give up majority share.” So, he’s asking 51%. I said, “Generally you’ll see it at 70 to 90%.”

So, normally, if the seller keeps any piece at all, which is I’d say less common, it’s a smaller piece. Five percent, 10%, 20%, that kind of thing. But yeah, you’re not gonna be able to raise 20% or whatever, give away 20% to an investor, and you keep majority. That’s not how we operate, no.

Joe:                        Yeah. I would also say in general, it’s not gonna be done in a stock sale kind of situation. So, you’re not gonna retain an equity piece. It’s more gonna be some sort of long term earn out, a contractual earn out on the business.

Justin:                   By the way, we were talking about the Amazon affiliate to FBA business model strategy, and Jon Haver actually came up with that over at Authority Website Income. He did a followup piece to how well that’s going, I think it’s like two months in. And he had some kind of idealistic framework for how much he thought he’d make, and then he put the actual numbers next to it. So, it’s really interesting to see what was over, what was under. So, I’m gonna link to that in the show notes if anyone wants to check it out. We also got a really interesting mention over on the Ahrefs blog about building thousands of links without any outreach. They asked some questions about our evaluation tool, and so we shared some information with them. And they asked, a bunch of people actually, on how they got these links. And so it’s all around creating tools and that kind of thing. I thought it was pretty interesting, and I’ll link to that as well.

Joe:                        Interesting. I’m a big fan of their blog, and I’d love to see us being mentioned over there.

Justin:                   All right man, that’s it for episode 148 of The Empire Podcast. Thanks for sticking with us. We’ll be back next week with another show. You can find the show notes for this episode and more at EmpireFlippers.com/ProfitFirst, and make sure to follow us on Twitter @EmpireFlippers. See you next week.

Joe:                        Bye bye, everybody.

Speaker 2:           Hope you enjoyed this episode of The Empire Podcast with Justin and Joe. Hit up EmpireFlippers.com for more, that’s EmpireFlippers.com. Thanks for listening.