Profit First in Australia: does it survive BAS?

Profit First is Mike Michalowicz's, and the mechanic is genuinely good. Instead of treating profit as whatever survives the year, you take it off the top as the money arrives, along with your own pay and a tax bucket, and the business runs on what is left. Operating expenses become the residual rather than a budget everything else has to fit around.

It works because it is behavioural rather than financial. Money you can see in the trading account gets spent from the trading account, whatever a spreadsheet says it was for. Moving it out first is the whole trick, and it is a better trick than it sounds.

The problem is that the book was written for a market that has no GST, and Australian owners keep implementing it off their bank balance.

What breaks

A tenth of the deposit was never yours

If you are registered, a share of most of what lands in the account belongs to the ATO and is being held on its behalf. There is no equivalent in the US model, so there is no step in the method that removes it.

Allocate a profit percentage off a GST-inclusive deposit and you have just set aside a slice of somebody else's money and congratulated yourself on the discipline. It feels like the method working. It is arithmetic done on the wrong number, and the shortfall turns up on a quarterly cycle at exactly the moment the buffer is meant to help.

Pass-through costs

The second one is not Australian specifically, and it bites hardest in the trades, construction and anywhere with subcontractors or heavy materials. A builder collecting $200,000 with $120,000 already owed to subcontractors does not have $200,000 to divide up. Michalowicz does address this, with the idea of allocating from real revenue rather than from the top line, and it is the part of the method most often skipped by people implementing it from a summary.

Skip it and the plan works for two months and fails in the third, which is roughly when the subcontractor invoices arrive.

The tax bucket

The book comes with a table of target allocation percentages by revenue band, including one for tax. We are not going to reproduce it, and not only because it is his. It is built on US revenue bands and US tax treatment, and an Australian business has a structure, PAYG instalments and possibly a trust to think about, none of which a percentage from another tax system knows anything about.

What to set aside for tax is a question for your accountant or BAS agent, who can answer it in about a minute and will be right. It is not a question for a book, and it is not one for us either: we give no taxation advice, and not competing with the accountants who refer us work is the arrangement this firm is built on.

So does it survive?

Yes, and it is worth doing. The order just has to change. Two things come out before any percentage is applied.

• The GST inside the deposit, taken from your own BAS rather than worked out with a rule of thumb.
• Materials, subcontract and anything else that arrived with the job and leaves with it. Your own wages and overheads stay in, because those are what the residual is meant to cover.

On a month where $198,000 landed, with $18,000 of GST and $55,000 of subcontract, what is actually there to allocate is $125,000. That is 63% of the deposit. A five per cent profit allocation is $6,250, not the $9,900 the bank statement suggests, and the $3,650 difference is money that was always going to have to be handed over.

That gap is the entire argument for doing this properly. A business allocating off the gross deposit is not being more disciplined than one that is not. It is being more confident about money it does not have.

The part the method does not answer

Once the percentages are set, the residual either covers what the business costs to run or it does not. The standard answer when it does not is to force the operating costs down until they fit, on the reasoning that costs expand to fill whatever they are given.

Often that is right. Sometimes it is how a business ends up unable to deliver what it sold, which is a worse outcome than a thin profit allocation. We would give the gap as a number, for the period and for the year, and leave the judgement with you. Lowering a percentage is also a legitimate answer, and the habit of taking something off the top matters more than the size of it.

Start smaller than feels impressive. A profit allocation you actually leave alone beats a larger one you raid in the second month, because the thing being built is the habit.

How it reads in a lending file

Neutral to good, with one caveat. A business holding a genuine cash reserve and not living on its overdraft presents well, and the reserve is the part a credit team notices rather than the method behind it.

The caveat is the several bank accounts. Separate accounts are what make the method work, because the money has to be somewhere you cannot casually spend it. They also make a set of statements harder to read, so if a facility is coming, be ready to explain the structure rather than leave someone to work it out.