17 TPE Part IV - Chapter 9-converted

The author discusses the concept of treating money as the lifeblood of a business and emphasizes the importance of regularly saving cash flow. They introduce the Profit First Account (PFA) as a way to accumulate a cash reserve for the business. The author suggests transferring a percentage of every deposit into the PFA and gradually increasing the percentage over time. They also highlight the benefits of having a PFA, such as financial stability, increased business value, and access to lines of credit. However, they caution against taking out money too easily, PFA-ing too much too quickly, and not considering legal protection and business growth. The author advises putting the PFA in an interest-bearing account and encourages readers to take action by calculating their profit-first percentage, starting with a manageable percentage, and setting up an interest-bearing PFA. Chapter 9, A Good Solid Flood A penny saved is a penny earned. Benjamin Franklin Recently I received a notice congratulating me on donating a gallon of blood. After some Wikipedia research, I learned that the human body has slightly over a gallon of blood pumping through it. Clearly, if I gave a gallon of blood in one sitting, I would be a goner. Shoot, even if I donated one-third of my blood, approximately three pints, in one sitting, I might suffer some tough consequences. But since I donate one pint of blood at a time, my body hardly misses it and I can donate as frequently as seven times a year and not miss it. Apparently, my donations piled up and in a very short time I had given a gallon of blood. Cash is the lifeblood of your business. I think it's hard to argue otherwise. Shouldn't you treat your money like the blood of your business? Just as blood is often required in a medical emergency, a business in fiscal trouble often requires an infusion of capital. You never know when a patient will need donated blood. But with a pool of easily accessible blood reserves, the chance for survival dramatically increases. Sometimes your business problems are predictable and other times they will blindside the hell out of you. With a supply of easily accessible cash, the chance of business survival dramatically increases. Do you see the value in regularly donating business cash flow to your reserves? The best system is to take your profit first. What do I mean by this? Every time money comes into your business, and I mean every time, automatically transfer a percentage of that money into a separate account. Just like a pint of blood, a healthy business will hardly feel the withdrawal. In fact, if you do it first, you will never miss it. I like to call this reserve the Profit First Account, or PFA. How much money can be transferred into the PFA without threatening the health of your business? Most stable companies should be able to post a profit of 10% to 25% after all expenses. So start with a low threshold wherein maybe 5% of all inbound dollars go into your PFA. Over time, slowly increase the percentage and monitor cash flow closely to see if your business gets woozy. Don't stow away too much money too quickly. Just as donating way too much blood in one sitting is harmful, rapidly draining cash from your business operations could cripple or kill your organization. Once you've adjusted expenses and cash outflow to sustain your PFA withdrawals, you will quickly accumulate a tremendous cash reserve. Should tough times come knocking on your door, and they often do, you will have your PFA to back you up and, if necessary, bail you out. Of course, as your cash reserves grow, they will ultimately be in excess of any imaginable rainy day need. At that point, you should take portions as an equity distribution. Trust me, it's a real nice way to reward yourself for running a healthy business. If you've never given blood, I strongly encourage you to do it. There's no question it saves lives. If you don't currently donate money to your company's PFA account, I strongly encourage you to start. There's no question it saves companies. Applying the PFA Process to Your Business As with everything in your business, your profit-first account isn't going to happen unless you take action. Start out slow and easy and build your way up. Here are the steps to take. 1. Research financial trends on Yahoo Finance to determine what healthy businesses in your industry earn in profit. Calculate industry profits as a percentage of revenue. For example, I studied many service-slash-investment companies and determined that 20% is a healthy profit number and is achievable among the top-performing companies in my industry. 20% is my profit-first percentage, PFP. That being said, 20% may be too much money for a young business. So initially, your company may be best served by having 5% of revenue going to the PFA, adjusting contributions to 8% in the following quarter, and 11% in the next, and so on. Continue to ratchet up the PFA savings slowly but surely, quarter by quarter, until you are at the optimal amount determined from your research. 2. Establish your PFA so that it is not easy to transfer money out of the account. 3. Immediately transfer your PFP, profit-first percentage, from every deposit made as a result of sales, and I do mean every deposit, into your PFA. Use the remaining percentage of money deposited to run your company and pay your salary. 5. Distribute 50% of the PFA balance to equity owners, hopefully just you, on a quarterly basis and leave the remaining 50% in the account for backup. Here are some benefits of the PFA. The PFA is always available as a rainy day fund, but it better be a serious storm. I mean thunder and lightning and stuff. 2. You will adjust spending and build a healthy business using the money left over after you withdraw the PFP. You will probably even earn additional profit on the leftover money. 3. The PFA is a simple monitoring system. Once you have an established PFA for a year or so, you can watch the trend of the PFA at distribution time. If the PFA is growing, so is your business. If the PFA is flat or going down, so is your business. 4. A company that shows a consistent or increasing profit quarter after quarter is much more valuable to a prospective buyer. And you want this, since when you sell your company is when you make some real money. 5. The PFA is a way to get big lines of credit. The more you have stashed away, the more lenders are willing to lend. Good luck trying to get a bank line of credit if you don't have any money. But as your PFA grows and banks know you have cash, they will gladly offer you lines of credit and so will others. Consider your line of credit as a second rainy day fund. This PFA plan is simple and it works, but make sure you avoid the stumbling blocks. 1. If the money in the PFA is easy to take out, it's tempting to borrow from it and screw it up. The money must be secured and not easily accessible. To address this, team up with someone whom you trust and will hold you accountable. Have her co-sign on your PFA account. Set it up so your co-signer cannot withdraw money, but both of you need to sign a check in order for you to take money. Similar to how two people must turn a key to release a nuclear missile. Just like that. 2. PFA-ing too much money too fast can be a drain on your company. A lot of people get too gung-ho about this system and start taking the gold PFP, not the starting PFP, immediately and then give up when their company has no money for expenses. The fix is to start now, but to start slow. Give yourself and your business time to adjust to the PFA by starting with a small PFP. Even if it's just 1%. 3. Believe it or not, PFA money grows very quickly. Within a few years, the account can actually grow so much that it becomes a risk should there be a lawsuit or some other crisis. If you are in this position, be grateful. Then, on an annual basis, talk with your attorney and your accountant and determine how much of your PFA you should cash out or spend. You could use it to make a major purchase, for example, or it could be your personal year-end bonus. It is nice being the owner. Try to strike a balance between legal protection, business asset reduction, and keeping enough in the coffers should a disaster strike. 4. Pushing profitability forces slower growth, since that money can't be used to invest in marketing or sales. The discipline of having profit from day one greatly outweighs the loss of faster growth. With the PFA, you are assuring your wealth. By growing fast, you are gambling your wealth. I suggest you don't gamble. 5. For goodness sake, make sure you put your PFA in an interest-bearing account. Don't just put this in a checking account. You are putting this money away for quite a while. Have it work for you, not go on vacation. Put it in a money market or other stable interest-bearing liquid investment. Take action now. Completing the next three steps could save your business and make your life. Not doing it will put your business in jeopardy and completely stress you out. Just do it. 1. Using the method outlined in this chapter, calculate your goal profit-first percentage. 2. Identify a starting PFP that you can easily manage. Most people start around 5% and go up from there until you reach your goal PFP. 3. Set up an interest-bearing profit-first account and start funneling your starter PFP into that account each and every deposit. 3. Set up an interest-bearing profit-first account and start funneling your starter PFP into that account each and every deposit.