The traditional foundational formula of Gaap – generally accepted accounting principles is sales minus expenses equals profit. That’s the foundational formula that most businesses use. That’s what we’ve been told by accountants and bookkeepers and
Thi is an axiom. An axiom is something that is just assumed to be true because it’s what we’ve been told so it’s been adopted as the truth. the prior generation believes it to be true and so it is. It makes logical sense and when something is logical therefore it must be true.
But there is something called The priming effect. This is when something comes first, we put more significance in it. We put significance in the words that come first.It’s human behavioural psychology. What comes first we put more value in and then we justify the remainder of the words based on the order of them.
You cannot differentiate each word and each word actually has an equal weighting from a logical perspective.
And so when we look at this formula >> sales minus expenses equals profit.
We are saying that sales are the most important thing. And then we look at expenses as the next most important thing. And then finally, the thing at the end, that no one looks at is profit. Well, sales are important but not so much that we can mitigate profit.
There are a lot of business that have lots of revenue that go bankrupt!
Revenue can actually be a kind of stress factor. The more sales you make the more weight it is on the organization to deliver on those sales. If you sell thousand dollars of stuff. You have a thousand hours of obligations. If you sell a hundred million dollars of stuff, you have a hundred million dollars of obligations. So, it actually puts more stress on the organization as sales increase.
Expenses, of course, is how we support those sales. We incur costs to deliver the service or product and then the remainder is profit.
So, in the priming effect most businesses identify sales and expenses as the most important thing. Maybe in your business you think just like this. “I just need to keep on growing and my cash flow will be fixed.” This is the result of a Salesman’s attitude to business. I need to grow and grow. One day I will be profitable and my debt will be gone. Okay, an approach, but more often than not, that one day will never come because you’re in the habit of selling. More selling, more expenses and on it goes. You say stuck in that pattern hoping that one day, money will flow into your business and that is simply not true.
Profit needs to be baked into a business and that happens by incorporating a new habit. By implementing the Profit First system, you will establish the necessary habits to be permanent profitability overnight as it’s the first step.
It will also address that priming effect of sales – expenses profit.
Sales are still important. If you don’t have sales, you don’t have a business however we’re going to simply subtract the profit out first. And the remainder is what we’re going to use to pay expenses.
This is the new formula. We have sales coming into the business. We take out profit, and expenses come last now. Here’s what happens now – we are primed on sales and profit and we can see that we need to sell stuff that’s profitable. That’s exactly how we want to position our business.
We allocate the remainder to expenses. Basically is reverse engineering profitability.
We take our profit out and what is left is what we run our business from. If you can’t pay your bills from what is left, this clearly tells you that you can’t afford the bills.
The important part of all of this is for you to understand the priming effect is absolutely critical. Whatever comes first is a priority and it will get done. If something comes last it means it can be delayed and even perhaps never dealt with, which means that it’s laid into perpetuity until it becomes so overbearing that becomes non-existant.
Now let’s talk about expenses. We have to ensure that are expenses live within what is available, what is left over. So we may have to look at cutting expenses, if we don’t have enough money left over. There can be a couple points of resistance that come up.
Some people say, “but I’ve never been profitable I can’t have a profit until I am profitable.” That’s actually not true. If you’ve never been profitable, you must start taking profit first so that the process will identify what expenses you can afford. Take your profit First – reverse engineer your profitability to identify the expense budget.
I’ve also had people tell me that they have too many expenses right now to become profitable and need to wait until their sales grow or become static. False. That’s not true either. We need to grow the business with a consistent cushion of profit before we can expand expenses. Often times what happens is that as revenue grows, expenses grow at the exact same rate.
So let’s discuss Parkinson’s law and the small plate principle concept here. Parkinson’s Law states that whatever is available will be what you will use – whether that is time or money or resources. Parkinson was a theorist of the 1950s and he said that based upon the availability of a resource, our consumption will increase or decrease accordingly.
This is why you will get that work project done, regardless of whether you have ten hours or one hour. When we have less time, we consume less content. We will fit in whatever we are doing, spending, having in the space available. So the less money make available for expenses, the more frugal we come because we have less to spend but the more Innovative we come.
By taking our profit first, we are suppressing how much money is available to spend and Parkinson’s law becomes our ally. If we don’t take the profit first, all the money comes in and is available to spend. In our subconscious mind, we automatically grasp onto it and Parkinson’s law becomes our enemy. More money, more spending and we justify every expense.
Here’s the deal with justification. Have you ever been in an argument with someone then suddenly you realize, during the argument, that your wrong. Well, it’s human nature to still defend ourselves, even when we know we’re wrong and that leads to justification. We also get into the Possesion Effect – once we possess something we put significant value on it, building almost a logical defense around protecting that possession. The Possesion Effect, coupled with Parkinson’s law, can be dangerous or can be our ally. It’s dangerous when we have money – all the money that comes in is immediately available for expenses because that checking account has all the money.
We now possess that money. We want to do what we want with it or make a decision to spend it or use a certain way. We defend that decision. Even if it’s a bad decision. Profit first circumvents those two things that work against us.
Here’s an example: So say that you have desired a Porsche. You decide to buy that Porsche. Now you have it. So now you will go to Extraordinary Measures to retain it. Say you can’t afford the Porsche though, and you get behind on your payments – the bank will send us a threat to repossess the car. Well, more often than not, we go to extraordinary measures to keep that car. Perhaps working a second job, borrowing money we can’t afford, refinancing our mortgage. When the reality is, you can’t afford the car so you need to get rid of it.
So enter the small plates principle. By reducing amount of money available for exenses, we reduce expenses! Having the money going into different accounts now shows us what the money is intended for prior to spending it.
The last thing I want to share with you from the behavioural psychology point of view is that the human mind will revert to what is right front of us as urgent. So when bills are stacked up, we look at the bills on top first and we even look at BILLs first. We don’t think about the long-term consequences of cutting the unnecessary expenses. This would be a more valuable investment of our time.
When we preallocate money to a purpose, it circumvents that reaction to just pay whatever bills there are and deal with paying ourselves or paying tax later. We decide up front what’s important. We must pay ourselves. We must save money for taxes. So by dividing the money up prior to using it, we see its intended purpose and we make make more prudent decisions.
So there you have the basic principles around the small plates. If your looking for permanent probability, who doesn’t want that, this is one reason why Profit First works.
2018 . COPYRIGHT | MICHELLE COOPER
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