How to Become Permanently Profitable

How to Become Permanently Profitable with Mike Michalowicz [Transcript]

I speak to many business owners. They’re putting in the hustle, working hard day and night to get sales. Once they get sales, they have expenses, only to find out at the end of the quarter or the year that they didn’t turn into a profit. Why? Because of our mentality and what we’re trained to do is sales minus expenses equals profit. I’m very excited about my next guest, Mike Michalowicz. He is the author of Profit First, Surge, The Pumpkin Plan and Clockwork. Mike shares the concept of Profit First, which is you’re always looking for profit first.

In this interview, Mike graciously spells out the Profit First formula and how it’s applicable not only for your business but also for your personal life. He also spoke to the importance of if you don’t focus on profits first and you leave it for last, many of the things that you left for last don’t end up happening. We spoke about the concept of if you do Profit First, what it does for you other than getting the profit is it also forces you to make tough decisions for your business. Sometimes it’s expanding your offering, sometimes it’s arriving to initial service but more importantly, sometimes it will force you to save some money with your expenses. It’s very possible that you could save between 5% and 10% only by going through your budget list and making sure that there are no extra expenses on that sheet. Without further ado, here is my interview with Mike.

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Mike, thank you so much for joining me on the show.

Meny, it’s a joy to be back with you. Thanks for having me.

You and I have connected a couple of years ago. You have spoken at one of our events. I want to start with a positive story after our last event where you spoke. A day or two later, somebody emailed me I should call him. I spoke to that person and he told me that it’s the first time he heard about the concept of Profit First. He went ahead and opened up an account in a different bank and he kept on updating me. Because I knew that I’m going to have you on the podcast, I asked him if he is willing to share how much money he saved and he told me, “You wouldn’t believe me. I saved $32,000 in that account and I’m a person that never ever saved a penny.”

Thank you for sharing this story. I’m grinning from ear to ear right now.

When we speak about no-nonsense advice for our audience, you are one of those people that I constantly bring back. I had your event and we had a webinar in the past because what you’re sharing is changing the mindset of a business owner and I want to get into it. Share with our audience a little bit about your backstory. I think your story has so much inspiration that will put things in context.

What put me on the trajectory of being an author for small business owners was that I have been an entrepreneur for the entirety of my life. I still owned some businesses, but there are other people running them. In the past, I was in the thick of it for many years. What I found was even though I had success from the outside, I was able to sell two of them. One was a private equity transaction, another a Fortune 500 acquired. The insides were dying like these businesses were never profitable. They were struggling. I stepped in this mentality saying, “Success is an exit.” It’s pumping up a business and then dumping it as fast as you can and repeating it.

I tried a third endeavor that I can immediately leave off my resume. I started ten company simultaneously as an Angel investor and they all collapsed. It was horrific. I evaporated all of my wealth I’d accumulated up to that point. This was my mid-30s. I had to come home to my family. I’ll never forget, it was February 14th, which is Valentine’s Day. I received a call from my accountant. He said, “Mike, I can’t believe I’m saying this to you, but it’s my professional opinion that you declare bankruptcy. The client’s been so fast.” Even though logically I knew my bank accounts were dwindling, emotionally I hadn’t accepted it. I thought something magical would happen. Big investor would come or a big client will save the day.

I had to go home to my family that day and tell them what the consequences were. We had no money and we’re going to lose our house. We lost it 30 days later. We are going to lose our cars and our possessions. The darkest part of this was I had to face my daughter who was nine at the time and tell her I couldn’t afford to pay for horseback riding lessons. That’s her passion. It was $20 to go to a group session once every couple of weeks. I was broke. I told my daughter this and her eyes welled up and she ran out of the room to run away from me.

I respected that emotion and feeling to run away from our problems, but the thing was she wasn’t running away. She ran to her bedroom to get her piggy bank and she ran back down to me and she said, “Daddy, if you can’t provide for us, I will.” It was devastating and embarrassing and I was disgusted by myself. I was also very proud of her. Think in this context, this piggy bank was wrapped in duct tape and rubber bands, not that it was ever broken. She didn’t want a robber to steal her savings for a horse. Every time she earned a quarter or a nickel, she was putting it in there. That was the turning moment for me. It wasn’t like the next morning I woke up and said, “I got this figured out.” I knew from that moment on, I’ve got to fix a lot of things in my entrepreneurial life. I devoted myself to it ever since.

What was the next step that you started doing?

The next step for the next two years was depression. I’m not proud of it. I do share this because the most afflicted community in the world with depression is the entrepreneur community because of the highs we have and the lows we have. What I did start doing was writing down the things I thought worked. I thought profit was the bottom line. There are always different common sayings in our business that made a business healthy and I started to challenge them. I have a little journal. I started writing down why it’s not true. How could it be something different? I started to discover these formulas, Profit First is one of them and others I’ve written about. It seems like countless more to go. That inspired me to write a book. I came out of my first book and then my second and third and just been continually writing to simplify the experiences of entrepreneurship. Entrepreneurship is not easy, but to make the elements simpler as my mission.

I want to touch on a couple of points you mentioned with this journey. We had Brian Scudamore, the Founder of 1-800-GOT-JUNK?. He also has his book, Willing to Fail. It’s so important as entrepreneurs and the people out there speaking to entrepreneurs and small business owners to share that there is a struggle. The journey is not always looking positive and rosy so to speak. It’s important that we paint the picture exactly as it is. It’s not a fairy tale because if not, what happens is every stumbling block a person has is a reason to quit.

I think ego is something, at least for me, I needed to get in check. I’m grateful now for losing everything because my ego went away. It is a funny connection with Brian. I meet up with Brian every year for many years, face-to-face for about four days in an entrepreneurial group. There are 100 of us working together. I met Brian when he was starting 1-800-GOT-JUNK?. Here’s a guy sitting next to me who says he’s starting a business that removes junk and rubbish from people’s homes. I had a technology business at the time and I was this chock-full of arrogance. In my head, I was like, “This guy, Brian, what a fool. No one can make money in garbage. This guy is crazy.” Fast forward many years later, he’s got a $300 million or $400 million company and I’m the one begging my daughter to take money out of her piggy bank. It was such a wake-up moment that I needed to be very careful about judging other people. We don’t know their trajectory. We don’t know their backstory.

The good news for our audience is that we don’t have to lose everything. We have to learn the lesson because Mike has done it for us and Mike is here to share with us the Profit First things they could implement immediately to your business, to take you into positivity. Share with us the concept. In business, we all know there is income coming in, there are expenses going out. At the end of the day, we ask ourselves what is left. You turned out head on and you have a totally different way of looking at things. For those in our audience that are not familiar with the Profit First formula, what is it and how does it change the way we work?

The core challenge is we see what’s left and that’s how profit has been taught. That profit is the bottom line. The foundational formula is sales minus expenses equals profit. This is taught in every accounting book. Every entrepreneur discusses it in our vernacular. The bottom line you’re in is all about profit being last. The big a-ha I had was that from a behavioral aspect, it’s human nature when something comes last. It means it’s insignificant and can wait. That’s the last thing I’m going to do. We would never say, “I’m going to put my family last.” I’m going to put my family first or my loved ones first. When something is important to us, we say it comes first. When something is insignificant, we say it comes last.

What I found in execution when it comes to profitability, I was waiting until the end of the quarter, usually at the end of the year when tax time came to see if there was any profit. If there wasn’t, I was like, “Maybe next year.” I kept on kicking the can down the road on profitability. In the Profit First system, what we do is we flip the formula. It’s sales minus profit equals expenses. When I’m saying executions, every time we have a transaction, every time a sale comes into our business, we immediately take a predetermined percentage of that money allocated toward a profit account. It’s a secret hidden away account. We hide that profit away and then run our business off the remainder. It’s effectively, in essence, the pay yourself first system applied to business.

Speaking to a small business owner just getting started, maybe they’re one to three years in business and you’re running paycheck to paycheck trying to cover expenses, where does this start? Does it start with your pricing? Does it start with the accounting system?

You do set your bank and the foundation system. The starting point is to go to your bank and set up multiple accounts ultimately. In the Profit First book, I teach what I call the five foundational accounts. The very fundamental core level of a brand-new business or even established business should have one saving account at their existing bank, just for now and call it profit. Let’s say $1,000 deposit comes in. We’re going to take a predetermined percentage of it. I would argue, a business starting out should start with a very small percentage, maybe 1% or 2%. Because if I take 1% of $1,000, I’m saying $10. If I can run my business off $1,000, even without any significant adjustments, I’m sure I can run off by $990.

What will happen in the beginning is you start allocating money to a profit and you’ll start building what I call the profit muscle. You’ll say, “I can take 1%. What if I increase this to 2%?” At certain points, you increase the profit percentages. Now your business is going to start to “speak to you.” What it means is you’re not going to have enough money to pay your bills and this is what your business is telling you. If you want to achieve 5% or 10% profit, whenever it happens, if you want to achieve this level of profit for something that finally flogged your business. You may have too many expenses or not enough margin, but something needs to be fixed.

We have a saying here at the office, “If you can’t pay your bills as you take your Profit First, that’s your business telling you, you can’t afford your bills.” We’ve coached now countless businesses, actually over 150,000 businesses globally that have implemented Profit First. We’re estimating by the end of 2019, we’re estimating over 200,000 businesses with some form of Profit First implementation. What we found is that in these businesses, they can cut typically 5% or 10% of costs almost overnight. There are unused subscriptions, that unnecessary office space, unfortunately but often over hiring too many people. We can consolidate down to our best people in our office and in some cases, be more productive.

The first thing is to start thinking about your profit. Step two is you may start cutting expenses. In most businesses, up to 10% cost cut is pretty realistic and pretty doable. After that, there goes a margin discussion and that’s the biggest opportunity, “How do I dictate a higher premium for what I do? How do I expand my offering where by expanding it, my premium, the amount I can charge is way more than I can charge in the past?” That’s the typical roll-out of a Profit First system.

There’s a very important point over here. On the other side of the aisle, let’s say at our event when you speak about the Profit First, the person is saying, “I can’t cover my expenses. How could I still make a profit?” The answer to that, and what I’ve heard from you, is that if you can’t pay your bills, you can’t afford your bills, which means that your numbers are not adding up. If not now, when will you?

There was a behavioral psychologist named Northcote Parkinson. This gentleman was from the 1930s, 1940s. What he discovered is that from a behavioral aspect, it’s human nature that as a resource expands in its availability, our consumption automatically expands of it. When I had the privilege to speak at your event, one thing I shared was the concept of plates. The average-size food plate that we’d off of now if you go to any restaurant or what have you, has doubled in size in the last 300 years. Back in the colonial days of the US, plates were what we would now consider a coffee saucer or a dessert plate. Since plates have doubled in size, because human nature doesn’t change, the portions or servings are based on the plates like fill up the plate. That’s what they’ve always done and did in the past. That’s what we do now. Then we eat what’s on the plate, but since the plate serving has doubled, our consumption is doubled. Now our waistline as a society has doubled. The solution is to get some small plates. It forces you to have smaller portions.

This plays out with our expenses or anything. As revenue increases, I bet your audience can relate to this. They’re saying, “Every time I make another dollar, it seems it goes right out the door.” If that’s your experience, that’s Parkinson’s Law. As more revenue is generated in the organization, more money flows in, there’s more of that financial resource, cash. It’s human nature now to spend it. You log into your bank account. We see we have money and we say, “I can pay my bills. I can finally afford to do X, Y, Z.” The expenses continue to climb at a rate that’s uncannily identical to our revenue growth.

Sadly, I thought for my own business, there would be a day that enough revenue that magically a profit would appear, “I sold another million dollars of revenue. I would finally have some money left over.” That was never true and never will be true because of Parkinson’s Law. What we’re doing by taking our Profit First is we’re forcing the business to reduce the size of its plate. Instead of that $1,000 deposit, you may end up having to go through the entire system finding out you don’t have $1,000 to run your business. You only have $600 or $500 or whatever it is. Now, it’s giving you the right portion and we will adjust, we always have. This is human nature to adjust to our portions.

As far as the profit, you call it a savings account. Is this money for having a profit or would you say you’re allowed to use that money when it comes to rainy days or a hard month as far as sales?

The money is almost exclusively reserved for rewarding the shareholder. Let me give you an example, but there is an exception. If you own a public stock, I happen to own some stock in Ford. Ford sent me a check for $13 in profit distribution. I opened that check and I did not say, “I don’t deserve $13. We should plow it back or reinvest it in Ford. I did not return the money to them and say, “Go, Ford. Let’s go.” I also didn’t say, “I earned this money. I’ve got to drive down to the factory plant and do some work to earn this cash.” What I said into my head is I took significant risks. I invested in this business, Ford. I’m hoping the valuation, the value of the company increases, but the valuation could decline. Stock values could drop. This is a reward for my risk.

As a small business owner, we all need to realize we are shareholders in our own business. We’re little mini-Fords out there. You’ve invested and owned perhaps a substantial amount of stock, maybe even 100% of it. When profit comes out, that’s a reward for doing what the vast majority of the world population will never do, which is to invest in or start a business. Almost no one does. It’s about 7% of the world’s populations who are business owners and entrepreneurs. The global economy has you to thank for that because small business supports the global economy.

For taking on that extraordinary risks, that’s the reward. There is an exception, as that profit climbs up, the primary function is to reward you. If you have debt in your business, the only way to eradicate debt is to make more money than you’re spending, which is called profit. I need more money than I’m currently spending to pay off my past debt. If you have debt, we will use a large portion of your profit distributions initially to eradicate debt. Then once the debt is eradicated, because we’re in the profit habit, we’re always putting away that money into that envelope or on to that plate, that percent of money, the next distribution that comes out is available for you.

When the money comes out as another rule, and it’s all outlined in Profit Firstthe book, but one other element is as this money, that profit comes in and accumulates, we don’t use 100% of it to reward the shareholder. We typically use a percentage of about 50% of that to reward the shareholder and 50% retained by the business to build what’s called a cash equity position. That’s a fancy term for simply saying, if rainy day hits, this money is available to be the bank for you and not having to ring up credit cards or hope you can get a bank loan at the last minute.

What would you say is the reason why business owners are afraid of getting into this Profit First formula?

Because we’re human and it’s human nature that once we get into a routine, for our minds to wire around that. Many business owners that are resistant to Profit First say, “I don’t think this works. I’m highly skeptical of it. I don’t think it will work, plus my business has never been profitable up to this point. I need to be profitable before I can ever do this.” That in itself makes no sense. You can’t wait to be profitable to make a profit. You’ve got to start making a profit now. I think the hesitancy is these routines that we get into ultimately become grooves.

A lot of people in this mentality is lie, “I’m going to work harder to grow my business and I’ll work my tail off. I’ll work ridiculous hours.” What I challenge people is if that’s what’s going to get you to the next level, how long you’ve been doing that? If you’re a year or two into that, maybe that’s enough proof you need to understand that working harder is not the solution. We need to work smarter. What Profit First does by taking our profits first, it forces us to think selectively, smarter about the way we operate our business.

The other skepticism I get too is too simple like, “We might just take Profit First and everything will sort itself out.” That is way too simple. It is human nature to bring complexities in situations, but there’s a cool philosophy out there called Occam’s Razor. I think it came around in the 1200s and the core concept is this. Often, the simplest solution to a problem is the right solution. What I found is when people are willing to prove Profit First themselves, I accept skepticism. I did this for myself. I was ground zero, the first client of this. Many years ago, I’ve had 45 consecutive profit distributions. I didn’t believe this would work. I did have desperation. I was in real trouble. I decided I’m going to try this system out and create it as I went along and it worked for me.

I expect people to be skeptical. I expect them to say it’s too simple. I expected them to say, “I’ve been doing stuff my way for so long that I’m going to stick with it.” I challenge them and say, “How is it serving you?” If it’s not serving you, maybe you’re willing to take a little test. Try it out. Have that one account, try a small percent, 1% and see, “Does that work?” You can convince yourself it does or maybe not, but I think it may. I think it will.

To add on that, I had a conversation with the business owner and I went through his numbers and a lot of business owners will say, “I’m in the growth mode. We’re in the growth mode. All of a sudden, we need to reinvest.” I told them, “What are your profit margins?” He said, “My profit margin is 20%” I said, “What do you want to do in the next twelve months?” “I want to double sales.” I asked him, “How much is your sales?” He said, “$1 million.” I say, “That means you need to bring in $2 million. Do you know what it’s going to do for your expenses? Do you know what it’s going to do for your infrastructure? Are you ready? How about you don’t have to double your sales and you can still take out double the profit.” He says, “How is it possible?” I told him, “If you could increase your pricing 20%, you’re doubling your profit. That same $10,000, you made $2,000. All of a sudden, you’re charging $12,000, you’re now making $4,000, which you’re doubling your profit.” That’s what counts.

One of the things that people don’t realize to your point is that revenue is equal stress. The more revenue your business generates, the more obligation your business has to deliver products or services. Obligation is stress on the organization. Many of us are in this mentality of I’ve got to grow my way to profitability. I need to put on more stress, but they don’t have that counterbalance. By taking your Profit First, to your point, a business that takes 20% profit on $1 million is a much healthier business than $2 million business taking 10%.

Another conversation I had when we were discussing the Profit First for our audience, which is a good idea as well, are people that have larger payrolls. If you built another paycheck in that payroll system that goes for profit, call it the check made out to payable to profit and just build it into your infrastructure because those are expenses. Otherwise, all of a sudden after five, six, seven months, you have accumulated thousands of dollars of savings, which could then be distributed to the shareholders.

I’ll tell you one of the greatest joys I had. We have more than 150,000 businesses running Profit First. The exciting thing is we have about 3,000 documented case studies. These come in constantly. We probably get five to six a day. When I say case study, sometimes there are a couple of paragraphs, sometimes there are three-page documents. What we found, and this is fascinating, is that businesses that take Profit First, on average, grow faster than our competition than the industry. At first, it’s confounding because everyone knows it takes money to make money. You’ve got to reinvest the profit back. Here’s what we found. When the business starts taking the Profit First, they have to become much more critical of their spend and they go through a much better evaluation saying what works and what doesn’t work.

When every dollar that comes in can be spent, then we become much more loosey-goosey. We’re like, “I need to run these Facebook ads because everyone else does. I need to do this because everyone else does.” We’re randomizing our spend. When businesses take the Profit First, since you have less, you would be more selective in what you spend and ensure that it doubles your return on it. Additionally, many of these businesses narrowed down their offering. They become more of a niche specialist. They say, “Here are the things that we’re confident at, let’s invest in that. The stuff that we’re not doing so well at or not confident, we’re going to jettison that.” Profit First reverse-engineers niche specialization. A lot of you know, the riches are in the niches. I’ve experienced it and that’s the only thing I do. I pick a category and try to become the dominant player there. Profit First seems consistently from our research to reverse-engineer niche specialization and these businesses that become specialized, outstrip, outpaced their competitors and grow significantly.

Let’s turn to one question on a personal budget. We spoke about business. This applies to people living paycheck to paycheck and trying to save up for the rainy day or maybe that new house they want to buy. How does that apply? Is it exactly the same or is it different?

It’s a bit similar. Firstly, they have to realize that our business and our personal lives are intertwined. They are not separate. We have a big dependency on our business and its income and profitability to support our lifestyle. The reverse is true too. If we’re having difficulty at home, we bring difficulty into the business. They’re working simpatico. What we do with the business side to support a personal income is we have two predominant accounts. One is called the profit account. We talked about that. It’s profit distributions. I suggest taking those on a quarterly basis by the way. The other account is called owner’s comp. It’s what I call the lifestyle account. This is the normalized salary you’re going to get from your business for being an owner-operator. It’s substantially different than profit. Profit is a reward for being a shareholder, owner’s compensation, for being an operator within the business.

You adjust your lifestyle to live off that stream of relatively more and more predictable income and a profit is a nice bonus you get at the end of every quarter. I write about this in the book, there’s a chapter I call it Profit First Life. What we do is we set multiple accounts specific to its intended use. If you own a house, it’s mortgage account. If you’re leasing or renting, it’s a rental account and you store money there. If you have to save for the future of your children’s college education, we have college accounts. I realized you may not want this in all your bank. You may want to have some special fund or 529 plan or whatever, but we have to have distinct accounts for its intended use. I have an income account. What happens, my home accounts, when money comes in, I get my regular pay. That amount goes into my income account in my home bank and then I divide up based on percentages of the different outcomes.

We have one for vacation. When we go on vacation, we pay always cash because it’s all there. We know what our budget is because it’s in the vacation account. We have one for a car. We’re paying for a car that we don’t own because we’re making payments to this account called car mobile. When we were ready to buy our next automobile, we’re going to buy it for cash because the money’s been saved. It’s a great way of seeing where you stand in your preparation for something. When we borrow money or use a loan or financing or something like that, we are fast-forwarding the item or benefit we’re deriving, but we’re stretching out the pain of paying for it. We put on more and more liability. It’s that quick big, “I got the car I want,” but now the responsibility to maintain this payment for the next five or ten years during that time, other payments come on. Many people become beholden to their debt as it slowly but consistently accumulates. By setting up Profit First at home, we have found that gets rid of that debtor mentality and puts you in a position of strength.

I would add to it, which a lot of times, especially when you’re speaking on a personal budget side. It’s sometimes the unknown because you’re living out of one big account and then you have now auto bill pays and stuff going in and out of your account automatically. You don’t know what you can even afford. If you start doing this system of what you’re sharing, this is something for our audience to take action and start implementing. If you start doing something like this and then now you have a conversation with your spouse about a vacation, the conversation is real. You know what you could afford. You know what you can spend and you know how you’re going to pay for it.

That’s exactly it. From the sales side, if I’m the guy trying to sell you the car, what I want to do is show you small monthly payments, because most consumers look at, “What can I do to get by this month?” I know I can sell to that mentality, but when you go to a system like we’re talking about now where it’s, “What’s the entire cost of that car?” If that’s a $50,000 car, I have $30,000 in my account, I can’t afford it. If I wasn’t looking at it from that perspective, it would be, “It’s only a $327 payment every month for the next 40 years.” Companies, and I understand their approach, they’re playing games with the terms, the amount due but they spread over time. The perception is there’s less due because we’re very specific to the pain of the moment. That’s why coming over to Profit First system, when we looked at the entirety of the cost, we know if we can afford it or not and have a very candid conversation.

For our audience, the Profit First is a game-changing book. If you follow me for a long time, you’ve seen I recommended it in my top ten in my emails. I recommend everybody to go out and get it. We’ll have those resources and making sure that you’re able to get in touch with Mike and the work he does on Profit First and the rest of his projects. Let’s close with the following four rapid questions. A book that changed your life?

I would say How to Stop Worrying and Start Living by Dale Carnegie. It changed my perspective on how we can manage our own stress.

A piece of advice you get that you’ll never forget?

Frank Minutolo, my first business coach looks at me when I asked him a question about my customer base and what should I do. He says, “I’ll tell you, but don’t listen.” I said, “What do you mean?” He goes, “Never listen to the experts when it comes to customers. Ask the customer always. They know what they want. They often tell you through their wallets.”

Anything you wish you could go back and do differently?

This is pretty shocking. I would say no. I think I wouldn’t be here where I am now without learning through burning. I am grateful, as painful as it was, for all the mistakes I’ve made and I don’t think I’d change a thing.

I love this question because I asked this question on every episode and people that have achieved a lot of success will always say that they learned from their failure and they got here because of that.

The pain going through it, if you asked me when I was going through the pain of losing everything, “This is the one thing I want to avoid in my life.” It takes time past that injury to fully heal, then to appreciate how important it was.

What’s still on your bucket list to achieve?

My wife and I were going through our bucket list and it was about 100 things. I’ll give you the most absurd thing. The one thing is to see Pat Benatar in concert because I grew up to her music and never saw her. I bought the tickets and I’m off to see Pat Benatar. The big crazy bucket list would one day to be a host for Saturday Night Live. I don’t know how I could ever pull that off. I don’t have the fame or I’m not positioned for it but that is a big crazy dream I have.

Please keep us posted if that’s happening. Mike, thank you so much for joining us. I know your time is valuable and that is why in the name of our audience, we will forever be grateful for sharing some of your time with us.

It was a joy. Thank you for having me.

Thank you so much.