Profit First Percentages: How to Allocate the Right Percentages to the Right Accounts
Profit First Percentages, Target Allocation Percentages or 'TAPs' are the backbone of the Profit First financial management system developed by author and entrepreneur Mike Michalowicz. It is a simple but effective system that helps businesses achieve profitability by prioritising profit and cash flow management. One of the main concepts of the Profit First system is Target Allocation Percentages or TAPs. TAPs are a predetermined percentage of revenue you allocate to different bank accounts to ensure your business is operating profitably. When implementing Profit First, you must have the correct target allocation percentages to make the most of the system. In this blog post, we'll look at how you can do that.
Profit is essential for the long-term sustainability of a business. Small business owners rely on their business profits to pay their bills, support their families, and save for their future. Without a profit, a small business will not survive in the long run. Simply put, you need to make more money than you spend to get the business outcome you’re looking for, e.g. improve your lifestyle, follow your passion, give back to your community, or to grow your business further.
Profit First is a popular method for achieving small business profitability because it provides a straightforward financial management system that any business owner can understand. Regardless of your accounting or finance knowledge, Profit First is effective because it leverages the psychology of human behaviour to help business owners make better financial decisions. By allocating funds to different bank accounts based on a predetermined percentage, Profit First provides financial clarity and helps business owners avoid the temptation to overspend.
"By allocating funds to different bank accounts based on a predetermined percentage, Profit First promotes financial discipline and allows business owners to avoid the temptation to overspend"
To implement the Profit First model effectively, you first need to create five primary bank accounts that will be used to distribute your funds to. These accounts are:
- Revenue: This account is where all revenue generated by the business is housed. All money received from customers, sales, or any other sources of income should be deposited into this account. If you have a POS terminal or invoice clients, this is the account you will get paid into.
- Profit: After revenue comes in, a certain percentage of money should be distributed straight to the profit account. This money is set aside to ensure the business is profitable from day one. There are recommended ways to use the profit but that’s a post for another day. Moving money to a profit account first is the basis of the Profit First model.
- Owners Pay: This account is used to pay the owner a salary. The percentage allocated to this account is based on the owner's needs and is typically paid every two weeks or monthly. Note that this account is the next account you will distribute funds to after the profit account. As an owner, this means you get paid before taking care of your other liabilities.
- Tax: The tax account is used to set aside money for taxes. The percentage allocated to this account depends on the business's tax obligations, and the funds are used to pay taxes when due.
- GST (If you earn over $75k only): If your business earns over $75,000, you must register for GST. In this case, it's a good idea to have a separate GST account and set aside the GST you receive on your sales before calculating your other Profit First target allocation percentages.
- Opex: The remaining funds after transferring money to the other accounts are allocated to the Opex (or operating expenses) account. This account pays for all business expenses, such as rent, utilities, payroll, marketing and supplies.
The good news is with Thriday you can now do this at the click of a button!
For more complex businesses, such as trade related businesses, that subcontract work out and have higher material costs you’ll want to add a Materials and Subs account to make sure you’re covering the cost of subcontractors in a similar way you would GST. IMPORTANT: This money comes out before any other target allocations percentages are calculated.
By allocating funds to these separate accounts, Profit First ensures the business is profitable, and the owner is paid a regular salary before anything else is taken care of. It also helps the business plan for tax payments and covers expenses without using up funds set aside for profit.
To help you get set up with Profit First, Thriday has a handy sub-account feature that makes it easy to set up your Profit First accounts in minutes. Once you sign up for Thriday, you can create up to nine accounts with their own BSB and Account Number. You can assign a name to each account and quickly move funds between them based on your target allocation percentages.
Once your accounts are set up, you'll need to determine the right TAPs for your business. Every business is different, so your TAPs will need to be calculated based on your individual needs and business goals.
Step 1: Understand your Business Model
The first step to determining the correct TAPs for your business is understanding your business model. Different business models have different profit margins and expenses. Therefore, it's crucial to clearly understand your business's financial structure to allocate funds accordingly.
For example, if you have a service-based business, your profit margins are likely to be higher than a product-based business. You may also have higher overheads if you have a brick-and-mortar store compared to an online business. Understanding these differences will help you determine the appropriate percentages for each account.
By reviewing your business model, you can get a sense of the levers you have to work with when defining your TAPs. For example, if you have a lot of fixed costs like rent and salaries, you may need to allocate a higher percentage of your TAPs to the Opex account. On the other hand, if you operate in an industry with specific taxes you need to account for, you might need to have a slightly higher percentage assigned to your tax account.
Step 2: Analyse Your Financials
The next step is to analyse your financial statements to determine the current state of your business. This includes reviewing your income, balance sheet, and cash flow statements to understand your revenue, expenses, and cash flow.
To do this, you can sign up for Thriday, which provides these reports as part of its accounting and tax features. Once you register with Thriday, you will be issued a transaction account and Visa Debit card. Any income or expenses you generate will automatically be categorised and assigned for reporting. With these reports, you can quickly see how much income you earn and what your outgoings are.
Where your business starts with Profit First may not be where it ends. You may need to get on top of your cash flow, modify your pricing, consider any outstanding debts etc. Talk to the team at Profit First Australia and New Zealand to help you understand the best way to implement profit first for your business.
Step 3: Determine Your Target Allocation Percentages
Once you have a clear understanding of your business model and financials, you can begin to determine your target allocation percentages.
"The Profit account should be the first account you fund, with a target allocation percentage of 5-10% of your revenue."
Remember, if you’re business is more complex and has subcontractor and higher material costs such as a trade related business then your GST and Materials and subs should be allocated before making any other calculations.
After that, and for simpler businesses the Profit account should be the first account you fund, with a target allocation percentage of 5-10% of your revenue. The Owners Pay account should come next, with a target allocation of 50% or more of your income. The Tax account should be funded with a target allocation of 15-20% of your revenue. The remaining percentage should be allocated to your Opex account.
It's important to note that these percentages are guidelines, and you may need to adjust them based on your business's needs. Here are some typical TAPs that can be used as a starting point for companies implementing Profit First in Australia:
- Profit: 5-10% of revenue
- Owners Pay: 50% of revenue
- Tax: 15-20% of revenue
- GST : 10% of revenue (use if you are registered for GST and note this needs to be distributed before any other distributions are calculated)
- Opex: Remaining percentage of revenue
Step 4: Monitor and Adjust
Establishing the correct TAPs when implementing Profit First is essential to ensure that a business can achieve financial stability, growth, and long-term success. If you experience unexpected expenses, this will be quickly highlighted using the Profit First methodology & fast action can be taken.. It's also essential to seek advice from Profit First Australia Professionals to ensure that your TAPs are appropriate for the business's specific circumstances. Profit First Australia certifies bookkeepers, accountants & coaches in implementing the Profit First system, and you can connect with a trained professional via their member database.
If you don't monitor your TAPs, or you set up the wrong TAPs in the first place, your business can experience several negative consequences.
- Limited Profit: If a business allocates too little to the Profit account, it may not have enough money to build a financial buffer, invest in growth, or weather unexpected challenges.
- Insufficient Owners Pay: If a business does not allocate enough to the owner's account, the business owner may not be compensated adequately for their work, which can lead to burnout, stress, and other negative consequences.
- Tax Issues: If a business underestimates its tax obligations and does not allocate enough to the Tax account, it may need more funds to pay taxes when they are due, leading to fines, penalties, and other legal issues.
- Overdue Operating Expenses: If a business does not allocate enough to the Operating Expenses account, it may struggle to pay its bills on time, leading to late fees, damage to business credit, and other negative consequences.
Profit First is a highly effective method for implementing sound financial management practices to boost profitability and ensure business owners pay themselves first. The team at Thriday is proud to partner with Profit First Australia to be the official software solution for implementing this ground-breaking way to make your business profitable.
Target Allocation Percentages FAQs
What are TAPs in Profit First?
TAPs are the percentage of a business's income that should be allocated towards different expense categories, such as profit, owner's compensation, taxes, and operating expenses.
Why are TAPs important in Profit First?
TAPs are important because they help business owners allocate their income in a way that prioritises profit and financial stability while also ensuring that all necessary expenses are covered.
How do you determine your TAPs in Profit First?
TAPs are determined based on your business's revenue and industry-specific benchmarks. The Profit First book and system guide appropriate TAPs based on revenue levels and industry.
Can TAPs be tailored for individual businesses?
TAPs can be customised for individual businesses based on their specific needs and goals. The key is to ensure that the percentages allocated towards profit, owner's compensation, taxes, and operating expenses align with the business's revenue and costs.
How often should TAPs be reviewed and adjusted?
TAPs should be reviewed and adjusted regularly, such as every quarter or whenever significant changes occur in the business's revenue or expenses. This allows business owners to ensure that their income is being allocated in the most efficient and effective way possible.
Profit First offers a clear, easy-to-follow framework for making your small business profitable. By implementing Profit First, small business owners can gain greater control over their finances and achieve long-term financial stability and success. By engaging a Profit First Professional and using Thriday, you can make the most of understanding your business model, analysing your financials, and implementing the correct target allocation percentages.
With the combination of Thriday and Profit First Australia and New Zealand, implementing Profit First, forming good habits and giving yourself the ability to make quick, smart financial decisions has never been easier.