Poor financial strategies and accounting controls cause many practice owners to struggle with cash flow. As a consultant for Vision Source, part of my job is to help peel back the layers and understand the various financial challenges that practice owners face. It could be that costs of goods are too high, occupancy is too high, the practice is spending too much on wages, or the owner is just not careful about their operating expenses. While I had become pretty good at analyzing the finances of a practice, until recently, I didn’t have a good strategy to address poor cash flow other than to tell practice owners to spend less money.
A few years ago, while in New York at Vision Expo East, I was approached by a CPA who had attended one of my courses. A few weeks following this chance meeting, he sent me the book Profit First by Mike Michalowicz. I started reading and immediately realized this could be something useful for the entire profession.
From there, I took the contents of the book, became certified as a Profit First Professional, and adapted the strategy for optometry. I then presented the concept to a large group of trusted Vision Source practice owners who immediately recognized the value. I’ve since developed it into a formal course and have been teaching it across the country for the last five years.
Reverse Engineering GAAP
One of the rules the IRS requires businesses to live by is called “GAAP” — generally accepted accounting principles. The most basic GAAP formula says:
Sales – Expenses = Profit
With Profit First accounting, we simply reverse engineer this formula to become:
Sales – Profit = Expenses
When we do this, we are putting profit first. We are making profitability the most important financial consideration in our business, even before paying our expenses. That’s an important concept because it sets the foundation for everything else we do with the program and understanding why this works.
Human Behavior Based Strategy
One of the primary reasons that Profit First works is that it’s a human beheavior-based strategy — not a traditional accounting or bookkeeping process. It allows us to use our cell phones and desktop computers to provide clarity about our business.
Most of us are in the habit of doing something called “bank balance accounting.” This is, we use our bank account balance to make some determination about how the business is doing. If there’s money in the bank, we think we’re successful. If there’s no money in the bank, we panic. The point is, our behavior changes based upon the amount of money we have in the bank at any given time.
One of the core principles of Profit First is something called Parkinson’s Law, which loosely means that the demand for something is directly related to its availability. The idea is that if more of something is available, the greater the demand. For instance, if we have a plate of 20 cookies, we’ll probably consume all 20. On the other hand, if there are only 10 cookies available, we would consume less. When less of something is available, we naturally consume less of it. We can use this strategy in our businesses as well. When less money is available to operate our business, we naturally become more frugal and innovative, discovering alternative ways to get things done. That’s the fundamental strategy of Profit First.
Putting Profit First into Action
Most practices run their business out of one business bank account. This means all the money that comes into the practice — money from patient payments, insurance payments, credit card transactions — all that money goes into one account, and then we pay our bills out of that same account. It’s the constant expansion and contraction of this account that creates stress and anxiety for the owners, and a lack of clarity about the business. At any given moment, there may be a surplus of cash available, only to find the account drained the next day due to a payroll run or a large vendor payment.
To combat this, we stop paying bills out of our main operating account and only deposit income into this account. We even rename this account calling it the “Income Account.” We then open four additional bank accounts that are linked to this account in such a way that we can easily move money from one account to another (as easy as using our cell phones). We give these four new accounts very important names: Profit, Owner’s Compensation, Taxes, and Operating Expenses. Once a week, we allocate a certain percentage of the money in the Income Account to each of these accounts, such that the Income Account goes to zero, and each of the four additional account balances increase. Bills are no longer paid out of our old operating account, but instead paid out of the new account we have designated as the Operating Expenses Account.
So, why bother with all of these accounts? You will probably agree that profitability is critical for a practice to survive. If we are not profitable, we are unable to sustain ourselves as a business. Profitability allows us to reinvest back into the business, hire more staff, replace the carpet, remodel, and buy new technology. By taking our profit first, before paying the expenses of the business, we ensure that our business remains profitable.
In addition, we need to ensure the owner’s of the practice are compensated fairly, and we do this by allocating a certain percentage of our practice income to the Owner’s Compensation account. This ensures that we are providing a fair market wage to our most important employee, the practice owner.
As long as we are profitable, taxes are inevitable. To cover this burden, we allocate a portion of income to cover the tax burden of the business. The Tax Account is intended to cover all the taxes of the business (excluding payroll taxes which are paid out of the Operating Expenses Account) such as quarterly estimates, state and local taxes, property taxes, and even reimburse the owner for taxes paid through a W-2 wage. We do this because many practices show a “profit” on their Profit-and-Loss statement at the end of the year, yet don’t have the cash available to pay the taxes. Setting aside the financial resources needed to meet any tax burden is a critical tax planning strategy and can be accomplished with the Tax Account.
Once we’ve allocated for practice profitability, pay ourselves a fair market wage, and pay our taxes, we must then learn to run our business on what’s left over. Just like we learn to build our personal lifestyle around our net pay and not our gross pay, we must also make sure we are allocating for the important things in our business.
Profit First works because it’s a structured plan. It caters to our human behavioral tendencies and provides much needed clarity into what’s really happening. It removes the emotion from running our business, allowing profitability to become a habit, forcing us to ensure the most important needs of the practice are met.