Profitability Begins with the Profit First Equation

As I expand my work with Amazon and other ecommerce sellers, whether it be through my business, speaking engagements, social media or other avenues, I see more and more the common threads that tie these unique, hardworking entrepreneurs together. One of those threads has to do with the debt they incur as they run their business, especially regarding inventory and operating expenses. Too many ecommerce sellers are relying heavily on credit cards and loans just to get by. And way too often they either don’t pay themselves at all, or they put it off until after taxes each year to see if they can even afford to take a paycheck. Is this how you’re operating your business? If so, read on and let’s change that today!

Inventory is of course the driving factor for ecommerce businesses. No inventory, no business. Likewise, no cash, no inventory. I’m sure you’re familiar with the mental gymnastics most sellers go through. As you stock your inventory, you’re asking yourself “Do I have the right inventory, and enough of it for the next wave of sales?” And then…”Where will the money come from to pay for that inventory and will it be enough to take care of myself and my family until the next Amazon settlement?” And finally…”If I borrow to restock my inventory now, how will I pay it back? Will I make enough with my next payout?

As you already know, ecommerce retail is a complex business model because of the inventory and required cash flow needed to keep it going. Profit First, the cash management methodology that sets up any business for success, works well for ecommerce sellers. Those that commit to the Profit First method have learned how to manage their inventory and operating expenses, and achieve their profit and growth goals.

Mike Michalowicz, creator of the Profit First method, and author of the book, Profit First, provides a framework for managing your financial activity in a way that builds in profitability from the very beginning. Drawn from a behavioral law called Parkinson's Law, which proves that the consumption of any resource will rise to meet the quantity of the resource available, the old business equation “Sales – Expenses = Profit” can leave you struggling to make ends meet. In contrast, the Profit First equation, “Sales – Profit = Expenses” ensures that you are profitable from the first time you implement the method. In keeping with Parkinson’s Law, if you don’t take your profit first, your expenses will rise to meet your income and there will be little left over for profit. On the flipside, if you do take your profit first, the funds you have left for operating expenses will be less but this will help you to operate more efficiently and be more frugal when it comes to spending.

The Profit First method basically consists of four primary steps, although it can be and often is expanded upon as it is implemented. Step 1 involves creating multiple bank accounts. I suggest starting with one checking account for inventory and another one for operating expenses. You should also add savings accounts for Profit, Owner Pay and Taxes. Step 2 includes moving funds from your operating expense account to the other accounts, following a prescribed sequence. It may feel cumbersome at first, but after a few cycles it will become your habit. The temptation to spend when the profit account balance increases is a bit irresistible for some. If this is you, then Step 3 is critical! I recommend moving that account to a bank that is less accessible, such as an investment account at another financial institution. And finally, Step 4 involves developing a rhythm in how you manage your funds. Over time you will spend less and less time working in your business, leaving you with more time and money to work ON your business.

This is a very basic overview of Profit First, but I thought it important to go over it again for the newbies out there. Follow this process for a few months to get a good base of data and then you can begin streamlining the process to gain better control of your inventory, operating expenses and most importantly…your profit.

 

To learn more, I invite you to check out my new book, on Amazon here Profit First for Ecommerce Sellers and at bookstores everywhere.