Ask Julia: Are you familiar with “Profit First”?
Dear Julia,
Are you familiar with profit first? I started reading about it but then hit pause because I know your class starts soon. I don’t want to be getting into two different processes and ultimately confusing everything. Unless your accounting approach dovetails will Profit First.
Sincerely,
Goal Oriented Flower Farmer
Dear GOFF,
Great question! And I’m glad you’re thinking about profits up-front.
Too often, farmers (and entrepreneurs in general) grow/make things, sell things, pay for things, and then hope there’s a profit left over to support themselves.
Especially for mission-minded farmers, profit often takes a back seat to rebuilding the soil, providing clean affordable food, and promoting social justice. It shouldn’t; you still need to live a comfortable, whole-hearted life. You can’t follow through with your goals and values if your personal well-being is compromised. So you need profits.
The first question is: how much profit do you need? What are your living expenses? What are your retirement savings goals? Are you saving for kids’ education? Do you have student loans to pay? Take a few minutes to figure out your number.
The second, bigger question is, how do you get there?
Many times a business owner will start with revenue… How much can you sell? And how much will you earn. Then you calculate the expenses… what will it cost to run the business? And then you see what you have leftover for profits and hope that you’re getting close to your goals. As a formula, it’s expressed like this:
Revenue – Expenses = Profits
The “Profit First” model turns this formula around. Instead of subtracting expenses from revenue to see what kind profits you’ll have, you subtract profits from revenue, to see what you can budget for expenses.
Revenue – Profits = Expenses
Full disclosure, I haven’t read the book, though I’ve read articles about it. I can’t say how my theory dovetails or not, but I can share my approach.
“Profit First” sounds great, doesn’t it? Decide what profits you want to earn, and then create your expenses budget based on what’s left over. The reality is far more complicated.
Let’s say, you want/need $50,000 in profits, and you estimate you’ll have $120,000 in revenue. That leaves you with $70,000 in your budget for expenses. Is that realistic? Can you hire enough staff to produce that volume of sales? Can you afford the equipment to produce those sales? What are the costs to deliver your products? And so on.
My challenge with the “Profit First” model is that it suggests that every expense is discretionary; if you can just cut back on your expenses, then you’ll be fine. It ignores the reality of production farming and the true cost of production.
Discretionary isn’t a good framework for expenses. I’ll offer that you have 2 types of expenses:
- Controllable
- Non-Controllable
The controllable expenses you can, well, control. But even within this category, there’s much you still can’t control. Yes, you can control your production and labor costs. But there’s a limit to how much. You still need a baseline of production supplies at a baseline quality/certification. Finding a less expensive supplier to meet your profit-budget goals may not be realistic. If, for example, you need organic, you need organic. End of story. Likewise, you can control how much you spend on marketing. But you still need to market your business and set a reasonable budget so you can achieve your sales goals.
The non-controllable expenses – mortgage/rent, property taxes, liability insurance – need to be paid regardless, and you have little control in managing these expenses. It’s not like you can shop around your property taxes for a better rate.
In other words, your budget for expenses needs to reflect the realities of running your business. You can’t just cut expenses or raise your prices to make your desired profit. You need to look at the full picture.
My approach
I agree that you need to build profit into your business model upfront. Certainly, you need to know your desired profit. This sets your destination. And I take a more wholistic approach.
You need to set your prices to ensure you can cover your costs and ensure you have the desired profits. (Is this “pricing first”??)
You need to understand your cost of production and other expenses so you can know what selling prices make sense. (“expenses first” ??)
Your prices need to be reflective of your marketplace. Pricing your tomatoes at $100/pound may get you to your profit goals on paper. But if don’t have a customer base willing to pay that price then it doesn’t matter (“market first” ??)
I use the break-even formula to set a revenue goal that pulls it all together.
I get into all the details of how to use this formula to come up with a sales goal, and then use this to create an annual plan in my upcoming class.
Profits are built into the model, but it takes into consideration the other aspects of your business as well. After plugging in the numbers, you may come up with a sales goal that feels untenable. You can then revisit all aspects of your number… ultimately, you need to lower your expenses to lower the sales goal number… but this can be achieved by
- Raising your prices.
- Modifying your product mix to focus on the most profitable items
- Reducing your operating expenses
I wish it were as easy as, set your profit goals and then limit your expenses to what’s leftover. But there is a process, a doable process, to build profits into your business model so you can achieve your goals.
Does this make sense? If not, feel free to reach out with questions.
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2 Comments
Hi Julia,
I was a Profit First professional (dropped the certification), but every expense is not discretionary. This cash flow method is about being intentional with your money and doing expense audits to determine if an expense serves you well (we both know everyone should do that periodically) and creating an envelope-type system with bank accounts so you can see your budget at a glance.
It benefited my farm and my consulting and hubby’s construction business, and I can tell you that I would have more money from our prior businesses if I had used this system.
I like to use it for creating budget goals.
Shelly Oswald
Hi Shelly,
Thanks for this added insight. As I mentioned in the article, I haven’t read too deeply about the “Profit First” model so appreciate you sharing these details.