So you stumbled upon or heard about the book Profit First and you're wondering if it'll work for people in real estate industry? I hear you!
The only other content I could find on the interwebs was Clayton Morris' article over on Morris Invest. However, it was a bit general and left some questions unanswered like:
- Is my rent considered total revenue or real revenue?
- Exactly how do I go about implementing this for my real estate business?
Like many people who delve into the world of real estate, I started my journey with the end set on early retirement via a large portfolio of rental homes. I thought, if I had 10 properties netting me $500/mo, I could essentially retire!
Not so fast boyo.
Along the way, I found I was making extreme sacrifices with my personal finances in the hopes of better business profits.
The worldview I kept repeating to myself was: If I invest $1 now, it will be worth $5 in some distant future.
Even after I successfully closed several deals, I was still crossing my fingers that no major repairs would come up, and hoping that everyone makes their rent payments on time this month. This type of thinking slowly cornered me into a scarcity mindset and led me down a path of artificial poverty.
Wait a second. Didn't we want a business to design itself around our lifestyle and not the other way around?
I went looking for answers...
I don't quite remember how I stumbled upon the book Profit First by Mike Michalowicz, but I knew within one chapter - this was going to be a game changer. This is exactly what I was looking for.
Why Profit First?
One of the primary building blocks of Mike's book revolves around how GAAP (Generally Accepted Accounting Principles) is utilized determining profit and how in the real world it does not psychologically work for entrepreneurs!
GAAP Formula: Sales - Expenses = Profit
Though this formula is technically true, entrepreneurs would gladly make sacrifices in time, money, and energy to make their business grow - the last thing they are thinking about is paying themselves a living wage.
However, Mike proposes a small but fundamental shift to the formula:
Profit First Formula: Sales - Profit = Expenses
Another fundamental concept in Mike's book is Parkinson's Law, which suggests that the demand for a resource increases to meet the supply of it. For example, when we are given two weeks to complete a project, it takes us two weeks. But when we are given eight weeks to do the same project, we also finish in eight weeks. By taking your profits first, Mike suggests we are grabbing Parkinson's Law by the horns and using it in our best interests.
If we only give ourselves only 50% of our typical operational expense to get the same things done, we might surprise ourselves with our own genius.
Of course, neither myself or Mike suggests you jump straight cutting your opex by 50%! There is an adaptation phase that can take some time. Mike brilliantly has baby action steps riddled throughout his book to help you make the shift.
Real Estate Specific Questions
To answer some of the questions posed at the beginning of this post:
1. Is my rent considered total revenue or real revenue?
In Mike's book, he mentions that a business should only adjust to Real Revenue if a significant portion of the operations requires materials and subcontractors that is more than 20% of the Total Income.
In the world of real estate, your debt service and HOA payments are usually more than 20% of your rental income. I set aside these fixed costs into the Materials & Subs account, and the remainder is sent into the Real Revenue account.
2. Exactly how do I go about implementing this for my real estate business?
To test the system out myself, I knew it needed to be dead simple. If it was too much of a hassle, I knew I wouldn't follow through.
To keep myself accountable to the system without having to continually calculate the target allocation percentages, I came up with the following spreadsheet to truly take the emotions out of the process!
Profit First Implementation Spreadsheet
In this spreadsheet, I layout the necessary baby steps to instantly become a profitable real estate investor and tame the psychological battle between you and your real estate finances.
In the first month, you should set up your bank accounts and set aside a mere 3% of revenue towards Profit, Owner's Pay, and Taxes. Even if you are accustomed to plowing back 100% of your revenue back into your business, surely you can keep things running on 97% of your usual budget.
Set your target allocation percentage in 12 months from now. The spreadsheet will linearly adjust your allocation percentages every month until you reach your target allocation percentage goal.
On the Profit First website, there is a post dedicated to helping you find a bank that supports the Profit First System in your area. After researching the Houston area, I found a local BBVA Compass bank had great starter business accounts with a $0 minimum balance.
Expect this process to take about an hour and for the banker to be a bit confused when you tell them you want to open up 7 free checking accounts.
Also, Mike suggests you open up a Profit and Tax Hold accounts in a separate bank since they are only to be accessed once a quarter. By having them at a second bank, it adds another layer to remove any temptations to borrow from your own Profit and Tax accounts. Out of sight, out of mind.
For my Bank 2, I found that the Barclays Online Savings worked best for me. They are a perfect contender as they offer leading interest rates (2%+), they don't have local branches and funds take several days to clear.
A sample workflow:
- Transfer Total Income (Red). On the 15th and 25th of the month, I look at all the rental income sources and move the corresponding mortgage/HOA payments to the Materials & Subs account. Then, I move the remainder of the Total Income account to the Real Revenue account.
- Distribute Materials & Subs. Make online monthly payments to mortgages and HOAs.
- Transfer Real Revenue (Blue). Based on the target allocation percentages in the spreadsheet, I move the funds to the appropriate Profit, Taxes, Owner's Pay, and Opex checking accounts.
- Transfer Profit and Tax to Bank 2 (Orange). I move the funds in the Profit and Tax accounts from Bank 1 to the corresponding accounts at Bank 2. Out of sight out of mind.
- Transfer Owner's Pay (Orange). Distribute your own paycheck!
- Distribute Opex. Pay staff and other overhead monthly bills.
This entire process should take you no longer than 5 minutes to complete!
Trust the process and overtime you will adapt to running your business on less!
Need more help?
Shoot me an email me at firstname.lastname@example.org and I'll try to help ya out!