But after all the time and money you spend showing homes and writing purchase agreements, do you ever feel like you’re cutting yourself short?
Profit First is an accounting method that quite literally puts your profits before your expenses. This cash management methodology flips the script on the traditional way of accounting, ensuring that you secure your own profits before expenses. In this article, we'll walk you through everything you need to know to implement this system in your business and become more profitable.
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If you’re curious about how Profit First can change the way you use the digital envelope system and organize your cash flow, let’s first take a look at what Profit First accounting really is and the step-by-step system you can adopt.
What is the Profit First method?
The idea behind Profit First accounting is that you should pay yourself first 💵➕🧑💼and let the remainder of your cash flow dictate how much you spend on operating expenses. This turns the traditional profit formula on its head and requires some mindset shifts to fully grasp the idea.
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For example, if the traditional profit formula looks like revenue - expenses = profit, then you should look at the Profit First formula as revenue - profit = expenses. This formula flips the idea of when profit should be taken out. And while prioritizing profit may seem like a simple concept, real estate investors and small business owners have been prioritizing expenses in their cash flow system for quite some time.
Profit First was first introduced by entrepreneur Mike Michalowicz. And while the idea has helped many business owners budget more effectively since its introduction, it started really taking off in the real estate industry when investor David Richter wrote Profit First for Real Estate Investing and founded Simple CFO Solutions, LLC to help other real estate investors gain financial freedom.
The idea behind Profit First is that when you take a percentage of your revenue as profit right away, you become more profitable. In fact, you may even find that you reduce your overall expenses. Profit First allows you to safeguard your cash flow and prevent underpaying yourself.
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Why Profit First works for real estate investors
While the Profit First method was designed to be used in any industry, David Richter was the first to identify its potential for the real estate industry. Given the nature of the real estate business, that is, the changes to investors’ commission from month to month, keeping profit consistent can be challenging for the average real estate investor. But using the Profit First method can help guarantee your profit and help with bookkeeping.
This idea is surprisingly rooted in the concept of Parkinson’s Law, where work will expand to fill the period of time available for its completion. More simply stated, you’ll complete your work in the amount of time you’re given. So if you have a week to close a deal, you’ll end up taking the entire week to complete the deal.
The same is true for your profit and expenses. If you leave your expenses unchecked, you’ll end up using more or all of your revenue. So by taking your profit out first, you can guarantee your profitability before you use your money for expenses.
By prioritizing your profit before reinvesting your commissions into operating expenses, you can control how much profit you keep for yourself. With Profit First, you’ll know exactly what to spend and save for yourself.
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How do you calculate Profit First?
The Profit First system aims to calculate your profit by dividing your revenue into five different allocation buckets: Real Revenue, Profit, Tax, Owner’s Pay, and Operating Expenses. You can do this by setting up separate checking accounts for each of the buckets, also known as envelope accounts. But how exactly do you go about calculating Profit First and what envelopes should you create?
Profit First is calculated by using the formula: revenue - profit = expenses. ✅ While the recommended percentages you take out for each bucket are determined by your revenue range, we can look at a general example to better understand this formula in action.
For example, let’s assume that your real estate commission is $10,000 this month (also referred to as Real Revenue). You’ll first set aside around 10% for profit, which will equal $1,000. Next, you’ll deduct around 20% for owner’s pay, equaling $2,000, followed by $1,500 for taxes. The remainder, $5,500 in this case, is left for operating expenses.
But Profit First goes even deeper by recommending very specific allocation percentages depending on your Real Revenue Range. Before we dive into the different envelope accounts you’ll need, let’s first understand the target allocation percentages you’ll be using.
What are the Profit First percentages for real estate investors?
Profit First recommends allocation percentages based on your total revenue using two different formulas: Current Allocation Percentages (CAPs) 🧢 — how your business finances are split between each bucket — and Target Allocation Percentages (TAPS) 🤏 — The target profitability of a given year.
For example, the specific allocation percentages that Profit First recommends vary between:
Revenue — Always 100%
Profit — Between 5 - 20%
Owner’s pay — Between 0 - 50%
Tax — Always 15%
Operating expenses — Between 30 - 65%
This chart by Mike Michalowicz breaks down what your Target Allocation Percentages (TAPs) should be based on your business’ Real Revenue, otherwise known as your Current Allocation Percentages (CAPs).
| A | B | C | D | E | F |
Real Revenue Range | $0 - 250K | $250K - 500K | $500K - 1M | $1M - 5M | $5M - 10M | $10M - 50M |
(CAP) Real Revenue | 100% | 100% | 100% | 100% | 100% | 100% |
(TAP) Profit | 5% | 10% | 15% | 10% | 15% | 20% |
(TAP) Owner’s Pay | 50% | 35% | 20% | 10% | 5% | 0 |
(TAP) Tax | 15% | 15% | 15% | 15% | 15% | 15% |
(TAP) Operating Expenses | 30% | 40% | 50% | 65% | 65% | 65% |
Let’s dig into each of the five Profit First accounts a little more to understand how you’ll use each when implementing this profit-focused accounting method.
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What are the 5 Profit First accounts for real estate investors?
Similar to envelope budgeting, for Profit First you’ll want to separate your expenses into different envelope accounts. When you follow the Profit First methodology, you’ll create one account for each allocation bucket:
💰 Revenue: The main checking account where your total revenue will live.
💸 Profit – An account where you’ll transfer your profit each month.
💸 Tax – An account where you’ll keep taxes to be paid out quarterly or at year-end.
💸 Owner’s Pay – An account where you’ll keep profit to be paid to the owners of the company (or yourself).
💸 Operating Expenses – An account where you’ll keep the cash needed to run your business.
The accounts work by automatically transferring allocated funds into each bucket every month. For example, using the recommended percentages if you make $100,000 in commission in a given month, $100,000 will land in your Real Revenue account.
From there, $5,000 will be transferred into your Profit account, $50,000 will be transferred into your Owner’s Pay account, $15,000 will be transferred into your Tax account and, finally, $30,000 will then be left over and transferred into your Operating Expenses account.
Unfortunately, the problem is that most banks charge fees for every additional account a real estate investor opens. In fact, this is a common challenge for many real estate investors looking to create different accounts for each of their rental properties.
With all this in mind, it can be challenging to find the right bank to implement the Profit First method. So, what should you look for when choosing the best bank for implementing the Profit First method?
What is the best bank for Profit First for real estate investing?
When searching for the best bank for Profit First as a real estate company, you’ll want to analyze a few important features, like the number of accounts offered, monthly fees and transfer rules. Simply put, it’s essential that your bank allows you to open multiple accounts and transfer funds with ease, without charging you extra.
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Many real estate investors love using Relay (that's us!) for Profit First banking because it provides the tools they need without any extra fees.
Relay is also the official banking platform for Profit First—and it comes with helpful features like:
✅ Up to 20 free checking accounts: With no fees or minimum balances on any of your accounts, you have the ability to set up deposit-only accounts for each of your properties, as well as operating expense accounts. This gives you greater clarity into the profitability of each property.
✅ Percentage-based transfers: You don’t have time to calculate your percentages each month, which is why Relay does it for you. Relay offers a percentage-based transfer making it incredibly easy to automate account transfers into each of your allocation buckets.
✅ 50 physical or virtual debit cards: Relay offers up to 50 debit cards that can be assigned spending limits for ultra-rich transaction data to help you quickly understand where your money is going. This means you can close a property deal, set up the necessary deposit and operating accounts and issue a virtual spending card for that operating account in minutes.
✅ Multiple LLCs under one login: When your properties are under separate legal entities, banking can be quite chaotic. But Relay allows for multiple LLCs under one login, so you can have visibility into your profitability across all accounts.
If you’re ready to give Profit First a try, open a free Relay account in just a few minutes today!
