How Profit First works
Profit First, from Mike Michalowicz's book, flips the usual order. Instead of sales − costs = profit, it takes profit first: every deposit is split by percentage into separate bank accounts for profit, your pay, tax and running costs, and the business runs on what lands in the running costs account. The percentages are shares of real revenue: sales minus materials and subcontractors, because that money passes straight through to suppliers.
The book suggests making the transfers twice a month (on the 10th and the 25th) and starting each account at the percentages your figures give today, then moving toward the targets a point or so each quarter. Jumping straight to the targets usually leaves too little to pay the bills.
The suggested target percentages
| Real revenue | Profit | Your pay | Tax | Running costs |
|---|---|---|---|---|
| Under 250,000 | 5% | 50% | 15% | 30% |
| 250,000 to 500,000 | 10% | 35% | 15% | 40% |
| 500,000 to 1 million | 15% | 20% | 15% | 50% |
These are the widely published starting targets; the book's bands are in US dollars, and published tables differ above 1 million, so above that the calculator uses the last row unless you type your own. Treat the tax row with care: 15% is a placeholder, not a rate. How much to set aside for tax shows how to work out your own figure.
A worked example: an electrician
A Perth electrical contractor had sales of $380,000 (without GST) over the last 12 months. $100,000 went on materials and subcontractors. Other running costs (the van, insurance, tools, an apprentice, software, phone) came to $154,000, and the owner drew $96,000. (Made-up figures to show the arithmetic.)
| Amount | |
|---|---|
| Real revenue: $380,000 − $100,000 | $280,000 |
| Running costs today: $154,000 ÷ $280,000 | 55.0% |
| Owner's pay today: $96,000 ÷ $280,000 | 34.3% |
| Left for profit and tax: $30,000 | 10.7% |
| Target (250,000 to 500,000 row): 10% profit, 35% pay, 15% tax | 40% running costs |
| Running costs at the target: 40% × $280,000 | $112,000 |
| Running costs above the target | $42,000 a year |
| Profit and tax at the target: 25% × $280,000 | $70,000 (against $30,000 today) |
| Quarters to close a 15-point gap at 1 point a quarter | 15 (about 3.8 years) |
The owner's pay is already close to the target ($98,000), so the problem is running costs: they take 55% of real revenue against 40%. Moving one point a quarter takes almost four years; cutting $42,000 of costs gets there at once, and most owners do some of each. Where is my money going? shows how to find the costs that grew in Xero.
A $10,000 deposit is split like this: $2,632 to materials first (materials are 26.3% of sales), then of the $7,368 left, $737 to profit, $2,579 to the owner's pay, $1,105 to tax and $2,947 to running costs. Press "Load the worked example" above to see it in the calculator.
Getting the figures from Xero
- Open Accounting › Reports › Profit and Loss and set the dates to the last 12 months.
- Sales is Total Trading Income. Add up the cost of sales lines for materials and subcontractors; every other expense is a running cost.
- For your pay: a company owner on wages takes their own wages and super out of running costs. A sole trader's drawings are not on the Profit and Loss; run the Balance Sheet or the account transactions for the Drawings account. How much can I pay myself? covers both.
- Add each Profit First bank account to Xero as a bank account, and record the moves between them as Transfer money, so they stay off the Profit and Loss.
Profit First is a cash habit; it does not replace a forecast. If the running costs account keeps running dry before the next transfer, a cash flow budget shows which months are short, and the net profit calculator shows what is moving your margin.
Questions
- What are the Profit First percentages?
- Profit First (from Mike Michalowicz's book) splits real revenue into profit, owner's pay, tax and running costs. The widely published starting targets are: under 250,000 of real revenue, 5% profit, 50% owner's pay, 15% tax and 30% running costs; 250,000 to 500,000, 10%, 35%, 15% and 40%; 500,000 to 1 million, 15%, 20%, 15% and 50%. The book's bands are in US dollars, and published tables differ above 1 million.
- What is real revenue?
- Sales minus materials and subcontractors: the money your business actually earns for its own work. A business with $380,000 of sales and $100,000 of materials and subcontractors has $280,000 of real revenue. If you have no materials or subcontractors, real revenue is your sales.
- What are current allocation percentages?
- The percentages your figures give today. Divide last year's running costs and what you paid yourself by real revenue; what is left is your profit and tax. $154,000 of running costs on $280,000 of real revenue is 55%. Profit First starts each account at today's percentages and moves toward the targets a little each quarter.
- Is 15% enough for tax?
- Often not. The 15% in the published table is a starting point, not a rate. What you need depends on your profit, your structure and where you are: a sole trader in Australia or the UK with a healthy profit usually needs more. Set the tax percentage from your own last tax bill, and add GST or VAT on top if you hold it in the same account.
- How do I set up Profit First in Xero?
- Open the extra bank accounts at your bank, then add each one as a bank account in Xero (Accounting › Bank accounts › Add bank account) with a bank feed if your bank offers one. Record the moves between them as Transfer money, not as spend or receive money, so they do not appear on your Profit and Loss.
- Where do I find the figures in Xero?
- Run the Profit and Loss for the last 12 months. Total Trading Income is your sales; the cost of sales lines for materials and subcontractors give real revenue; the other expenses are running costs. If you are a company and pay yourself wages, take your own wages and super out of running costs and put them in your pay. Sole traders' drawings are not on the Profit and Loss: look at the Drawings account on the Balance Sheet.
- Are my figures stored or sent anywhere?
- No. The calculation runs in your browser. Nothing you type is saved or sent to our server or anyone else. The only exception is if you ask us to email you the result: then your email address and a short summary of the result are stored, and nothing is sent until you confirm.
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This calculator gives an estimate from the figures you enter. It is not financial or tax advice. Profit First is a book and method by Mike Michalowicz; this tool is independent and not endorsed by him. Xero is a trademark of Xero Limited. This tool and ReportPilot are independent and are not made or endorsed by Xero.