These are the questions that led our interview with Mike:
1. Hi Mike, please share with us your background, your current business and how Profit First came to be in the first place.
2. What is the difference between understanding business and understanding business profitability?
3. What is the biggest common myth you see business owners fall for when they are having a cash crises?? Like…just grind through it and I’ll be fine.
4. What are the 4 core principles of Profit First? Is that the analogy to the 4 principles of weight loss and nutrition I read in your book?
5. Does Profit First work for any kind of business? How about for personal finances, how could you apply it?
5a. Work with your Natural Tendencies, not against them…what does that mean?
6. What are the 4 core principles of Profit First?
7. Explain what the Instant Assessment is please
8. How do you define “scaling a business” in a healthy way?
9. When it is OK to add on a new product or service in a biz on your opinion? Jack of all trades..master of none.
10. Is it OK for profit to go up and down after being in biz for 3 + years?
11. All new businesses need seed capital to start. What are your thoughts on that for peopel just launching their own business?
12. What are the 4 accounts everyone should have set up?
If you’re a reader… you can see the transcript below
Speaker 1: Welcome to the Seattle Investors Club Podcast with Julie Clark and Joe Bauer, where we share the nuts and bolts of real estate investing from our 20 plus years in the industry. Sit back, relax, listen, and immediately take action. Are you ready? Here we go.
Joe Bauer: Welcome to the Seattle Investors Club Podcast where we talk about the nuts and bolts of real estate investing, my name is Joe Bauer, I have my cohost, Julie Clark, on the call today, Julie how are you doing today?
Julie Clark: I am totally great, did you actually know, Joe, that my real name, you might not know, is Julia.
Joe Bauer: I did know that.
Julie Clark: Right? And your real name is Michael, right?
Joe Bauer: Yeah, which is a strange coincidence.
Julie Clark: It is a strange coincidence, we also have a third coincidence in our guest today on the Podcast is named Mike, right?
Joe Bauer: Yeah.
Julie Clark: [crosstalk 00:00:52] two Mikes and a Julie.
Joe Bauer: Two mikes and a Julie, yeah, so today, I’m very excited to have Mike Michalowicz, who is the author of Profit First, Surge, The Pumpkin Plan, and his new book, Clockwork, Mike, how are you doing today?
Mike Michalowicz: I’m doing well, and a big happy birthday to Julie.
Julie Clark: Oh, thank you, Mike, I appreciate that.
Mike Michalowicz: You’re welcome.
Joe Bauer: Yes, happy birthday. Well, I am incredibly excited to have you on the Podcast today, Mike, because Profit First has changed the way that we’ve done business so I thought it’d be super cool to have you on and hopefully, can help change other people’s businesses, that are listening to this Podcast. So thank you.
Mike Michalowicz: Oh yeah [crosstalk 00:01:37], my joy.
Julie Clark: I would say guys, this is going to be, probably out of all the Podcasts that we’ve done, everybody who’s listening, all our Podcast land people, those most important one so hopefully, you guys have your pens out, take some notes because we’re always talking about business and how to improve in our business but none of that matters if you don’t have any money to run your business, right? And I actually was an accounting major in college.
Joe Bauer: What?
Julie Clark: Yeah, I was.
Joe Bauer: Shut the front door.
Julie Clark: Heck yeah. And you know Mike, as far as I can tell, makes accounting fun. So I’m excited to hear what your twist is. It’s not really an accounting system, I think I read that. That’s really more of a plug-in, right?
Mike Michalowicz: Yeah, it is. It is. But when you said “account fun,” it’s like an oxymoron. A real jumbo shrimp type thing.
Julie Clark: Exactly.
Mike Michalowicz: Hopefully, I don’t know if it’s gonna be fun. It’ll be far easier than you’ve ever experienced, and it is a plug-in, meaning, it doesn’t replace accounting, it simply makes accounting cash-flow management components so easy, that the accounting almost takes care of itself.
Joe Bauer: Very cool.
Julie Clark: We know we love that, because all of you who know my partner Joe Bauer knows that he loves systems, right?
Joe Bauer: Absolutely.
Julie Clark: Talk about an easy system for one of the most tedious tasks that you could have on your plate, here we go with Profit First.
Joe Bauer: Absolutely, and Mike, you know I’d love to hear more about who you are, where did you grow up? What are some key moments that shaped you? So if you could share some of your background, your story, before we get into Profit First, I’d love to hear that.
Mike Michalowicz: Yeah, sure, sure. So my name is Mike, as you figured out. My real name is actually unpronounceable, it’s from space aliens, it’s [zickbuckzabador 00:03:34], and so I just go by Mike. Just like you go by Joe, even though you’re Mike. We all have that other weird name that’s our real name.
Julie Clark: I gotta tell you guys, what I can’t stop thinking about when we’re joking about all this stuff right now, have you guys seen Monsters University, that kids animated movie?
Mike Michalowicz: No.
Julie Clark: And the green guy on that movie is named Mike, Mike [Makowakowitz 00:04:01] or something like that.
Mike Michalowicz: Yes!
Julie Clark: Right?
Mike Michalowicz: Yes! I gotta say, I’ve heard of it, and people say, “You’re the green monster!” I’m like, “What?”
Julie Clark: Yeah!
Mike Michalowicz: So I think that is me. That’s my alter-ego. [crosstalk 00:04:13] My doppelganger.
Julie Clark: You know what, you even sound like him.
Mike Michalowicz: My doppelganger. And ironically, I look a little bit like him. He’s more attractive. But so I am … Where I grew up is in New Jersey, coincidentally in my office right now overlooking my office building, is in the town I grew up in. So I’m back where I grew up.
Joe Bauer: Oh.
Mike Michalowicz: My business partner and I are on a mission to eradicate entrepreneurial poverty, that’s why I wrote Profit First, and that’s what we’re trying to do also as a business, and we’re trying to make our town where we grew up the most profitable town in the country. So that’s why we’re back home. And then who I am, or my little backstory, I am an entrepreneur, had the good fortune of becoming an entrepreneur right out of college, start some business. I sold one to private equity, sold another one to a Fortune 500. I had all these wonderful experiences in cash events, and then I had the greatest event of all, was I lost all my money. It was the necessary wake up call, because my ego had the best of me. I thought I knew everything about entrepreneurship and just became a schmuck, to be honest.
Mike Michalowicz: And it’s the blend of arrogance and ignorance that’s deadly. I started a third business as an angel investor. Started all these different companies, and just had no clue what I was getting into. I thought that I was so start, and used all my money trying to fund these businesses. So when I was in my mid-30s, I became a millionaire, and then I also lost all my money and was on the verge of bankruptcy only two years later. And that became a restart for me. I was ashamed and embarrassed of how I destroyed myself, the damage it cost my family. We lost, actually, our house and our cars, and our possessions. It was a devastating period, but what I found was interesting is it triggered a question in me about what am I gonna do now?
Mike Michalowicz: And there’s a question, says, “If you had all the money in the world, what would you do?” It’s a very interesting question, because it’s the ultimate freedom. If you didn’t have to worry about money, what does your heart sing out to do? It also traps you, because it assumes you need all the money in the world to do what your heart sings out to do. But what I found, when I had no money to my name, I could ask that same question by simply saying with, “With no money in this world, what do I want to do?”
Mike Michalowicz: And when those answers were the same … I always wanted to be an author one day, and now that I was starting anew, I said, “You know what? This will be my vocation.” I started to write business books, specifically to address all the mistakes I made in my own business and hopefully serve other people that way.
Mike Michalowicz: So today, I’m an author, I’ve written multiple books. Profit First would be my most recent, and that’s what I do. Hoping to eradicate entrepreneurial poverty.
Julie Clark: I love that. Entrepreneurial poverty. That is a term that is right in your face, I think, and so true, right? That is … I haven’t heard I’d say, so … Or maybe I’m trying to ignore it. Maybe that’s-
Mike Michalowicz: Well, you know what the reality is. I call it entrepreneurial poverty. I don’t know if it’s a term that’s existed. But here’s what it is. And I suspect both of you can relate to it. The day you start your company, the first day, all of your friends who aren’t entrepreneurs look at you and say, “Oh my God, you’re a millionaire now. Oh my God, you don’t work at all, you just sit back and drink mai thais and margaritas, and you make millions.” And they think that by becoming an entrepreneur that we are extraordinarily wealthy, and have total freedom of time. Now the interesting thing is, that’s our goal, but the reality is, as entrepreneurs, most of us work redonkulous hours, exhaustive hours, and we’re not making a dime. The business may be making money, but we’re not taking any money. And that’s what entrepreneurial poverty is, is misperception of success, and wealth, and freedom, when we’re really entrapped and impoverished.
Julie Clark: Right. Yep. That is absolutely try. My family grew up, my dad owned his own business. My dad owned a pharmacy. And after I’m reading your book and things like that, I’m like, “Holy shit, that was totally my dad.” You know?
Mike Michalowicz: Yeah.
Julie Clark: And here I am very much so, potentially could be on the same path to that, right?
Mike Michalowicz: Oh yeah. [crosstalk 00:08:32] Entrepreneurial poverty is industry-agnostic. You could be a pharmacist, you could be a manufacturer, you could be a service provider, you could be an Internet marketer. It doesn’t matter what you do. This is a common entrapment. And there’s a lot of behavioral, I shouldn’t saw flaws, but just behavioral principles that we follow as humans that keep us trapped in this mindset. Most entrepreneurs are very focused on growth, rightfully so, you need to do that. But we negate or forget about profit. So we grow at the compromise of a healthy business, and that’s one of the root problems. We always think the solution is more growth. Like, “Oh, I’m not making any money. I need to grow more.” Not necessarily. We need to focus on what intrinsically in your business is making profit, and grow that, not just grow everything.
Julie Clark: One of the questions that I had written down here to ask you was, maybe understanding the difference between business versus business profitability, some people can be very good businessmen, like I think your point was, you know how to run your business and your focusing on running your business, but you have no clue about focusing on your business profitability. And you’re not watching that. You know how to run, you know your business really well, and keep everything going, but you have no idea, or you’re skipping over that business profitability review.
Mike Michalowicz: I discovered Maslow’s hierarchy of needs about five years ago. I mean it’s been around forever, but me personally, I first was turned onto it about five years ago. And I’ve been studying it ever since. I know see a correlation by the way Maslow’s hierarchy of needs and a business’s hierarchy of needs. Now, Maslow says we have physiological needs at the foundation of humanity. If you don’t have food, water, oxygen, that’s the only thing that matters. If you’re deprived of those things, that will become our sole attention. But once we have that, we go to the next level, which is like shelter. We need a roof over our head to protect us from the elements. Above that, once we have shelter, then we seek companionship, love, family. Above that, you can keep going up to self-actualization.
Mike Michalowicz: And business, I think we have the same hierarchy of needs. The foundation, I believe, is sales. If we don’t have a single sale comes into our business, all that matters is a sale. If no money is flowing into our business, we are starving for sales. So we get into this mentality of sell anything to anyone. The thing is, that’s the oxygen for business. You need sales to breathe, but it’s not the nutrition for a business. That’s what profit is. Profit is the food and water level. So yeah, once you have oxygen coming in, that’s good, but now we need to nourish this business. We need food, sustainability. Without it, we’ll starve to death. Yet most businesses just try to keep on breathing more oxygen. Like, “Oh my God, I’m starving to death, I need to breathe more. I’m starving to death, I need to breathe even more.” So they keep on trying to sell, sell, and sell their way into a nutritious kind of healthy business, and they’ll never get there.
Julie Clark: In our business, in the real estate investor world, to put that as a … Connect it directly to what we do, is I think what happens is that people buy these properties, they need to buy, buy, buy, and they say we’ll I’ll take less profit margin on this one because I gotta keep my cruise going. I’ll keep less profit margin or I’ll take a little extra risk on this one, like you say, it’s like sale, sale, sale. In our real estate investor with flipping homes and things like that, it’s buy, buy, buy, and take maybe less of a profit margin because it’s in some ways the same thing as a sale, right? It’s the product that we need in order to make that sale. Does that make sense, what I’m saying?
Mike Michalowicz: It totally makes sense. It make sense, like I understand what you’re saying, it doesn’t make sense because it crushes business. And there’s a saying in the entrepreneurial community, they say, “I lose money on every transaction, but I’m making it up on volume.” Right?
Julie Clark: Exactly.
Mike Michalowicz: Right? So it didn’t work this time, but if I do more of it, what’s not working, that’ll save me. And of course, when we see it from that way, it looks ridiculous. It actually digs us deeper into a hole.
Julie Clark: That’s what drives me crazy about our business, you hear people saying, “Yeah, I do a hundred deals a year, or I do …” I’m like, so what? How many of them make money? We do way less deals, but we do the ones that make money.
Mike Michalowicz: That’s the human ego. We see that all over the world. I remember once, someone emailing me and saying, “I’m crushing a business. I have 30,000 Twitter followers.” And I didn’t even know how to respond. I was so stunned, I’m like, “Okay.” But it’s kind of the how big is it contest, it’s this big, we’re waving our genitalia contest, it’s so stupid. Who cares about the size? What we need to start caring about is not how big it is, we need to care about how healthy it is.
Mike Michalowicz: So when business owners walk in and say, “Oh, I got a five million dollar business,” I respond saying, “Okay, whatever, tell me how healthy your business is.” And that’s when the real conversation breaks out. A five million dollars business that is losing money is way worse, is horrible. I’d rather have a $500,000 dollar business that’s throwing off a hundred grand to me every single year.
Julie Clark: Right. Exactly. Exactly. Yeah, this is a hot topic. I think that nobody talks about it freely. You never hear anybody talking about this freely amongst all these chats, and as a topic of conversation, about how healthy their business is. This is a very personal topic that we’re talking about today, that hopefully we can bring out and create a discussion amongst our community a little bit more, as far as that goes, or at least put people on the path to start asking the right questions.
Mike Michalowicz: I start blaming, this is where I put a little blame on the accounting principles. Now let me do a little disclaimer, I’m not saying that accounting is not important, but what I am saying is that there’s some principles that don’t speak to the behavior of the entrepreneur. And heres my challenge. The foundational formula for accounting is real simple. Sales minus expenses equals profit. That’s the foundational formula. You have to have sales. You subtract the expenses you incur, and what’s leftover is profit. The problem is, that formula, while logically, of course it makes 100% sense, but behaviorally, it’s telling us that profit is the last consideration. First we focus on sales, then we focus on expenses, and by the way we don’t say we’re focusing on expenses, we call it growth, right? We say, “Well, I’m investing, pushing back into my business.” And what’s leftover is profit. It teaches us that profit is last. And when something comes last, we delay it. When something comes first, we prioritize it. That’s why everyone talks about the size of their business and focuses on sales and growth exclusively, because that’s what comes first in the formula.
Mike Michalowicz: It’s kinda like health. If you, Joe, if you got rushed the hospital, and they say, “Joe, you gotta change your diet, you gotta smoking, stop drinking, do these things or you’re gonna die.” You don’t come out of the hospital and say, “You know what, starting today, I’m gonna put my health last.” You say-
Julie Clark: He’d probably be calling me on that, Mike.
Mike Michalowicz: He’d be calling you, yeah. [crosstalk 00:16:03] Those velvet cupcakes, for God’s sake, Julie. You’ll say, starting today, I’m gonna put my health first. As human nature, what comes first get prioritized, what comes last gets delayed and delayed. And that’s why for most of us, since sales and expenses come first, we talk about how much we’re selling, how many clients we have, how much we’re investing our business, how many employees we have, investing in employees, that’s expenses, we focus on that. And no one talks about profit. Instead, we look at our profit at the end of the quarter more often for some people, sadly, it’s once a year, when tax year comes. They look and say, “Oh, no profit, no money leftover for me. Maybe next year.” Literally, profit gets delayed another 365 days before it’s considered again. That’s the fundamental problem. Profit does not come last. Profit comes first.
Julie Clark: Right.
Joe Bauer: Yeah, so if we’re talking about terminology, and as we lead this Podcast and our club, how do you recommend starting to have us talk about our business and our profit, versus I made 50 grand on this deal, should be like … What are those terms that we can start talking about, so that other people can start talking about them, so that we can let it trick down a little bit more?
Mike Michalowicz: Yeah, in regards to terminology, the big one is how healthy is your business? So stop asking questions that are pointing towards size, like how many you did, that’s simply a transaction thing. How many employees do you have, how many projects are underway? That’s all about size. Instead, we should be talking about how healthy is your business? What was your take from the last project? What’s your profit margins? Be talking about that, because right now, if everyone talks about size, that becomes the metric that we measure and compare each other against. Someone else did three million, so I gotta do at least three million, maybe I can do four this year. And they hear that I’m trying to do four, and they’re like, well maybe I can do five. And we start this natural competitive spirit around revenue. And that’s the mistake. I think we … That’s human nature to compete. We want to keep that going. We just need to compete about something that benefits us all. It’s around profitability. So focus on health, profit margin, productivity. Results from a project. The profit per project, that’s the terminology we need to use.
Joe Bauer: Okay.
Julie Clark: That is all good stuff. I was reading in your book, you used the word, or you say, “Work with your natural tendencies, not against them.” What exactly does that mean?
Mike Michalowicz: Yeah, so it’s interesting. When you talk with most accountants, and they rightfully say this. They say, “Never look at your bank accounts.” When you want to know the health of your business, the biggest mistake is to look at your bank accounts, because they’re highly transactional. There’s money going in and coming out. So they’re not reflective of your business’s cash situation. So instead, look at these three critical documents: your income statement, your balance sheet, and your cash flow statement. Tie those in together. You should have other metrics that you know, like you KPIs, that’s your key performance indicators, your budgets. There’s a couple accounting metrics like the OCR, which is the operating cash reshare. The inventory turns is another very popular one. They tell you to look at these things. And the reality is, at least my natural tendency, I realized, is I didn’t know how to read those documents. I would try to fake it. But quite frankly, I’m not interested. I don’t have the time. I’m gonna log into my bank account, and follow a real simple system. It’s called my gut. And if I had money, I knew I could spend or invest it, and if I didn’t have money, I would panic and try to collect or sell something to somebody.
Mike Michalowicz: So one point in the book is, even though it accounts for 300 years now, I’ve been trying to get us to read documents and stuff, we are not logical beasts. We’re not Spocks. We’re more Captain Kirks out there. We’re much more in the flow of the moment. Our natural tendency is to look at our bank accounts. So instead of trying to change who you are, which is nearly impossible, instead use a system that leverages that natural behavior. We need a system that works with our bank accounts. We need a system that allows us to continue to log into our bank accounts everyday, if we want to, and know the exact state and health of our business.
Mike Michalowicz: And that’s what I did with Profit First. As my goal for Profit First, an accounting plug-in. It doesn’t replace accounting. Accounting still works behind the scenes. But your natural tendency, if it is to log in to your bank accounts, Profit First puts the system in your bank, any bank in the world, will set up a system in your bank, it’s very simple, that preallocates money to its intended purposes, so you know exactly what money is being used for what purpose, and you can run your entire business, at least the cash flow of your entire business, off your bank accounts.
Julie Clark: What would be … I know there’s some four core accounts, I think, that you use in Profit First. Can you tell our listeners what they would be so they-
Mike Michalowicz: Yeah, yeah. So in the original book, I called it the Core Four, I since have revised, expanded the book. It’s now the Foundational Five. I had to keep that alliteration in mind going on. But here’s what the Foundational Five accounts are. I believe every business minimally should have five bank accounts, and that one of the tips here is whatever bank you work with today, if you like them, keep working with them. You have a good rapport, that’s great. Here’s what they are.
Mike Michalowicz: First account is a checking account, and we’re gonna call it income. It’s sole purpose is a depository account. That means any money that flows into your business goes into this account. It acts like a serving tray. The analogy I use is Thanksgiving dinner. Julie, Joe, when you celebrate Thanksgiving, I suspect that turkey comes out of the oven, but what happens next is the host doesn’t say, “Hey, everyone, grab your knife and fork! Everyone for themselves! Just fight for that turkey, we’re leaving it on the serving tray! Fight, fight, fight! Carve it up yourself!” No, of course you don’t do that. Someone, the host, hostess, carves the turkey, and then the apportion it to every plate. Everyone gets a serving.
Mike Michalowicz: Of course, the reason behind this is so obviously everyone can eat something. Well, the same thing is with our business. The income account acts as the serving tray of cash. It’s a cash turkey, if you will. Our business will never eat off of that tray anymore, it’s a serving tray. But what we will do is allocate money from that account to other plates, so we carve off pieces or portions of it and put it on a plate so every part of our business has enough cash to survive.
Mike Michalowicz: Now, here’s the other parts of the system, the over four accounts. Income being the first, the next one is the profit account. This often a savings account, and the intention of this account is to first allocate your profit, hence the title, Profit First. Money flows into your business, we’re gonna take a predetermined percentage, you determine it, it could be one or two percent as your business gets healthier and healthier, three, five, 10, 20 percent. I know businesses now doing 60% profit, that they’re an outlier, but it could happen to you. So a portion of that percentage, of the income goes toward profit.
Mike Michalowicz: Next account is called owner’s comp. This account is used to pay the salary of the best employee your company will ever have, which is you, the owner. No one works as hard as you, no one’s as dedicated to the business as you, no one is as good a salesperson or operator. You are literally the best employee. The problem is, most owners don’t pay themselves, or don’t pay themselves adequately, and then we start to resent our business. We’re scrambling to pay our employees, and we never pay ourselves. We start to loathe our business. So we’re gonna start paying the true best employee, the owner. This is different from profit. Owner’s comp is the lifestyle, if you will, it’s the salary of the owner, and profit is a bonus above and beyond. It’s a cash distribution that is distributed every quarter or ever year. I suggest every quarter. It’s above and beyond salary. It’s a reward for being an equity-owner of the business, for having the courage to start out the business. Owner’s comp is a salary for being an employee in the business.
Mike Michalowicz: Two more accounts. Next one’s called tax. I know or I believe everyone started their business for a couple reasons. One of them, surely, is for financial freedom. We became entrepreneurs to have a lifestyle that’s financially free. We don’t have to worry about costs. And yet, when tax time comes, so many of us are terrified of the tax bill. How am I going to pay this? It catches us off-guard. Well, the definition of financial freedom is not worrying about that, so we’re gonna have the business worry about it. The tax account is an allocation of money from the income account that will pay the taxes of the owners, their personal income taxes, will be addressed by the business. And I know some people listening may have an S-Corp or a C-Corp, or an LSE or a LLP, or a sole proprietorship or hybrid. There are so many versions of companies out there. And the way you must submit your taxes works differently. But the company can always reserve your tax responsibility. The way it disperses the money, sometimes it’ll write the check to the government itself, other times it’ll reimburse the owner for the taxes they already paid, but ultimately the business will pay for the taxes of the owner.
Mike Michalowicz: And the final and last account is the operating expense account. This is what you operate your business off of. This is the lifestyle of the business. So basically, money comes in, income, I then put a percentage in profit, I put a percentage in my compensation, I allocate a percentage to taxes, and the remainder goes into operating expenses. And the key to understand here, is we are reverse-engineering profitability. If you want to be profitable, if you want to take pay, if you don’t want to ever worry about taxes again, this remaining amount in operating expenses is what you must run the business off of. So we have simply reverse-engineered our profitability, by taking our profit first and having these different accounts.
Julie Clark: Totally awesome. I know as soon as Joe read your book, immediately we implemented it, and what’s crazy is I’m the accounting person on our team, right? I was an accounting major, means nothing necessarily. Joe runs the show for us based off Profit First. It makes … Easily, it’s life-changing as you say.
Mike Michalowicz: Yeah.
Julie Clark: And there’s something about knowing, for me personally, that Joe’s putting tax money aside, that when I gotta pay my taxes, I always extend but hey, but you still have to pay when you accept it. If there’s money, it makes it almost feel okay, because he’s gonna send me some money.
Mike Michalowicz: Yes.
Julie Clark: That’s been sitting in that tax account, that I didn’t have to worry about or do math on with my own stuff, because of the way with LSEs or whatever.
Mike Michalowicz: This is where Profit First is a plug-in to accounting. You’ll see, it has not replaced accounting, it’s managed the cash flow behavior of an entrepreneur, so Joe is behaving like most of us entrepreneurs. I assume he’s looking at the bank accounts. Now he has a system where he can see very clearly where the money’s being allocated. The accounting still has to be done. But the front work has been done, that money’s properly apportioned. Now when we analyze the taxes, the job of the accounting department is, let’s try to reduce our tax requirements. There’s compliance and law that requires you to pay taxes, but we are allowed, and it’s lawfully allowed, to pay as little as possible within the rules. So the accounting still applies, but we now have the confidence that we don’t have to scrounge and panic for money. So that’s the beautiful thing.
Mike Michalowicz: But I also suspect Joe feels relieved, too, because he’s like, I don’t have to worry about the tax money. It’s already paid for. This is a thing called loss aversion, another behavior. So you know my little side passion is human behavior. I love reading behavioral books, and I work with a behavioral psychologist, understanding how we work, and one of the things I discovered working with a psychologist was the power of loss aversion. And loss aversion says once we possess something, like I’ve always wanted a red sports car. The day I possess it, now it becomes my baby. My sense of ownership once I actually have it skyrockets. And I will do anything to prevent its loss. That’s what’s called loss aversion. So if I buy that little red sports car, but the mortgage, or I’m sorry, the lease company comes to me and says, “Hey, you didn’t make a lease payment, we’re gonna repossess your car.” I will do extraordinary things to take possession of what I own. My little red sports car. So I will work a second job, I will cancel the insurance, and I’ll keep it locked in my garage. I won’t even drive the thing, as long as I don’t lose it.
Mike Michalowicz: Now here’s the irony. These are extraordinary things I did to keep what I have. I could’ve done extraordinary things to get it. I could’ve worked a second job to get that car earlier, but I didn’t. It’s only one we possess something that we start reacting in this extraordinary way. Well, it’s the same thing with money. Once we possess money, once it’s in our bank account, and then the government says you owe me money, we feel the pain of it being taken out of our bank account. So we go to extraordinary measures of panic and just start spending money elsewhere so the government can’t get their hands on it. But when we allocate according to the Profit First system, money to a tax account, I never feel possession of that money. That’s like keeping the little red sports car at the car lot. We never possess it. If someone else gets the red sports car, yeah, I wanted it, but whatever. Someone else got it, another one will come my way. If money’s been allocated toward taxes, yeah, it sucks that we owe the government money, but at least it’s not my money, so it doesn’t feel as painful.
Julie Clark: Right.
Joe Bauer: Absolutely.
Julie Clark: [crosstalk 00:29:28] I’m going through the emotions as you’re explaining that-
Mike Michalowicz: Right.
Julie Clark: I’m like, “Whoa, whoa,” going through all these emotions just listening to all this stuff. It’s crazy that it’s … By no means am I saying this is simple, but yet it’s simple. It’s so easy for everybody to put in place, it’s crazy how it will just change. Even if there’s no money, or there’s not a lot of money in these accounts. Having these accounts set up, and having this system work, there’s some sort of piece of mind. Like you feel safer, just because you did it. That’s how I feel.
Joe Bauer: Absolutely.
Mike Michalowicz: Yeah, yeah. And it is totally simple. That’s the idea. That’s the idea and that’s the challenge. So some people think, “Oh my God, it’s too simple. Can’t work.” Another component of human nature, is often we add complexity to things because we can’t believe that simple thing can have a great impact. So when people hear this system, it’s natural to have tons of skepticism. I suspect some people are listening right now, would say, “Yeah, it sounds so simple, but you don’t know my business, Mike. It won’t work for me. I’ve never tried this before. I’ve never been profitable before, and now you’re telling me take profit first? But I’ve never been profitable. I’ve already proved I can’t be profitable.”
Mike Michalowicz: So it’s normal that a simple system will get skepticism. What I tell people is I can speak ’til I’m blue in the face about how I believe this will work for you, but the only person that can prove it is yourself. So what I tell people is just get started in a small way. Just get a little taste of it. Just set up one account. So we just outlined the five foundational. But I think a business can start off with just one account, a profit account, and allocate maybe just 1% of their income. It’s inconsequential. It’s such a small amount of money. If you allocate that, it won’t impact your business. If you bring in 10,000 bucks, you allocate 1%, that’s 100 bucks. So, you can still run your business off of 9,900. But, what happened is, you’ll start seeing, “Wow, I have a little bit of profit accumulating,” and you’ll start testing yourself. “What if I increase that to two, or three percent?” It’s a way to kind of baby step your way in.
Julie Clark: It’s almost like a mental thing. You know what else I’ll say about this system is, Joe, don’t you have it set up that it automatically happens? You don’t have to do anything? You’ve got it auto … Do you have it set up that way? We’re talking about our business now.
Joe Bauer: Well, technically I am the auto person. So on the 10th and the 25th, I go in and allocate the percentages accordingly.
Julie Clark: But you know what I’ll say, though? When you have partners, people always have partnership issues and those things come up. To me, knowing that we have this system in place, also, and that this is our agreed upon, between Joe and I, what our splits are, right, there’s a trust factor there. Because he watches the books and I don’t.
Joe Bauer: Right.
Julie Clark: And therefore, I feel like it gives me, not of course that I don’t trust Joe, but I’m just talking in general for partners. There’s a level of trust. It’s so easy to check on. If you’ve agreed on what the percentage splits are to go to each account, and you can look at your serving platter, your income account I guess I’ll say, and you can easily see where’s going what.
Mike Michalowicz: Yeah. It’s so funny. So just look at world history. If we look at Enron, according to the accounting of Enron, they were profitable until the day they closed the doors, right? They laid off thousands and thousands of people. They bankrupted countless number of people, yet according to the accounting, they were highly profitable. But Profit First avoids the accounting gameship that Enron played and other businesses could play, because this is a cash-based system.
Julie Clark: Right.
Mike Michalowicz: So for that cross-accountability I have a business partner in one of my companies, too, and he and I both have full access to the bank accounts, and we can look at them any time. Secondarily, we have a bookkeeper, a third party bookkeeping company that does all the work in the accounting system. That’s a good checks and balances across from the bank, so now we’ve three sets of eyes looking at it. And because it’s so simple, my business partner Ron and I, we both can look at the bank accounts, and literally in under a minute, make sure that the transactions have been done appropriately, and that money’s being allocated according to our agreement. Within minutes. Less than a minute.
Mike Michalowicz: And it’s so simple now, that I could go to both of you, and you could look at my business and immediately tell how healthy we are. You could see how profitable you are, you could see how much the owner’s being paid, you can determine how we’re outlying expenses. And I just gave you the foundational five accounts. I believe as a business really gets into this, you may have eight, nine, or even ten accounts. And you can see what we’re saving up for a capital expenditure. We’re going to be developing some new software, but we’re gonna make the money’s in place to develop that first. So you can see how far along we are with that, all by just logging into our bank accounts.
Julie Clark: Right. And just the ability to check on stuff, and know that you’re making progress. I really believe it’s a very mentally comforting system. Regardless of how much money is in there or not, like you said, putting a hundred bucks out of the 10,000. It’s mentally comforting, which is a stress-reliever.
Mike Michalowicz: Yes.
Julie Clark: Right? Which is a stress reliever, which is a problem for entrepreneurs in the first place. [crosstalk 00:35:10]
Mike Michalowicz: My favorite, and I get these occasionally. I invite readers to email me. I love to have a dialogue. I literally spend an hour, plus, a day responding to readers and it’s a passion project for me. I love it. And the favorite emails I get, with some regularity, is a saved marriage. I’m not saying Profit First saved a marriage. They had the courage to implement the Profit First system. They saved their marriage. But what happened is, some of these couples are writing me saying, “We’re in business together.” Or, “I was the entrepreneur and my spouse had no clue what was going on in the business. Now they see how I’m managing the numbers, and the stress is gone. Even though the revenue hasn’t increased, I have absolute clarity of what money’s being used for what purpose. I have control over my business and know how to drive profit.” And that sense of confidence then bleeds out into the rest of their lives. Because I believe entrepreneurship and our life is like conjoined twins. When we started a business, we are lockstep with it. As the business goes, so do we go. If we don’t know what’s going on and we’re fearless and clueless about our business numbers, we are fearful and clueless about everything else.
Mike Michalowicz: But once we have control and assurity of our business’s direction, we have control and assurity in our business and our lives, and it brings about this degree of, like you said, confidence, stress reduction, and now … It’s influenced the relationships that people have.
Julie Clark: Exactly.
Joe Bauer: Wow.
Julie Clark: And you know in our industry, there’s a lot of couples, husband-wife teams doing this kind of stuff, flipping homes and being investors like that, so for sure. Let me ask you, because I don’t want to run out of time. What is an instant assessment? I’ve seen that term-
Mike Michalowicz: Yes, and instant assessment is something that’s in the book. So if you get Profit First, in the book, in there is a tool to instantly assess where your business stands, and then give you a course of action to take to get it right sized, if you will, or correctly positioned for profit. I have it for free download on my website, too, so if you want to skip the book and just get the assessment, you’re welcome to do that.
Mike Michalowicz: But here’s what it is. What we do is we evaluate your existing business, and where you’ve been historically. That’s our basis. How much profit have you taken? Everything’s on a cash basis. So this is not in accounting profit, not how much it says you made on your income statement. How much of a bonus check did you actually take home? How much did you really pay yourself? And so forth. And then what we do is we say, okay, this is where you stood. We now compared it to other businesses that are what we call the fiscally elite. Extremely healthy, profitable businesses. What kind of percentages are they doing based upon the revenue that you’ve been producing? It’s a comparative. And then between where you are and this comparison of the fiscally elite, we determine a path to get there. That’s the roll out. How do we slowly but consistently step you forward in profitability so your business can become part of the fiscally elite?
Julie Clark: And is this something that somebody works with your team on, or are they doing it on their own, an instant assessment on their own?
Mike Michalowicz: You can do it on your own. We have a team, we call it Profit First Professionals, these are accountants and bookkeepers who’ve become certified in the Profit First method and teach this, and guide you on the intricacies of it. But you’re welcome to do it alone. When I wrote Profit First, the goal was I just want to give everything to the reader so they can get going on this. If they want further professional help, we have the team ready, willing, and more than able. But you can do this on your own. The goal is just to get started.
Julie Clark: Let me ask you another thing. So when people … A lot of people come to us and they’re just getting started in the real estate business. Some people have money, some people don’t. But when you’re first starting out, obviously every company needs some kind of seed money, some sort of capital infused from the beginning, right?
Mike Michalowicz: Yeah.
Julie Clark: I would think, most likely. As far as the percentages go, is there like a starter set on that, or is it all just very personal on everybody’s personal situation, or is there kind of a standard goal started set of percentages on the account splits?
Mike Michalowicz: It’s funny, so when a brand new company is starting, I actually suggest they start at the fiscally elite level. Now, if you have to put seed capital into your business, that goes right into the op-ex account. So stay I had $50,000 to get started. I’m just picking a number. That’s not income, this is a loan that you’re making to the business, so that goes right into operating expenses, and that’s what you need to operate with. But then when you start generating revenue, start following the Profit First system immediately.
Mike Michalowicz: Now here’s the funny thing. We have over 75,000 companies doing Profit First. We actually are approaching 100,000 now. It’s in every industry. I found brand new businesses that start with the target allocation percentages of the fiscally elite, the ideal numbers, they don’t know better otherwise. So the first deal they get, they say, “Oh, I guess I gotta throw off a 10% profit. Oh, I guess I got 10% more is gonna go to me. I guess I gotta do this.” They just assume that’s the standard, and since they don’t know better, they do it.
Julie Clark: Yeah.
Mike Michalowicz: The great irony is if you’re starting out, start off right, and that’s the way you’ll live in most cases.
Julie Clark: Is that … Can you tell us what those percentages are, or do we find that somewhere on your website?
Mike Michalowicz: Yeah, my website, because it depends on your revenue, your targeted revenue range. It changes over time. So it could be 10% profit if you’re around a million dollars in revenue, but it could be 15% profit if you’re doing five or 10 million dollars of revenue. And I have about seven categories, so you gotta look through it.
Julie Clark: Okay.
Mike Michalowicz: You can go to my website. Can I share the domain?
Julie Clark: Yeah, let’s do it, because you know what, we’re getting ready to-
Mike Michalowicz: Okay.
Julie Clark: Wrap up anyways.
Mike Michalowicz: Okay. So I’ll give you a couple of things. It’s MikeMichalowicz.com, that’s my name. I realize it’s long, and Polish, and extremely hard to spell. Actually impossible to spell. My wife still struggles with it, just to give you a heads up. So here’s the dealio. My nickname in high school literally was Mike Motor Bike, the great irony is that I never have ridden a motorcycle. But I was Mike Motor Bike, so if you go to MikeMotorBike.com, that will forward you onto my website. The other way is if you like to use Google, type in my first name, Mike, I’m sure you know how to spell that. Hit the space bar and type in Mic, M-I-C. So Mike Mic, and you’ll see this long Polish name drop down by the time you push Mic in, and that’s me. Pick it, it’ll bring you to my website.
Mike Michalowicz: On the website, there’s a resources section. All this stuff is for free download. You don’t even have to register or sign up. Every book I’ve written, you can get, not all the chapters but free chapters, so you can explore it before you decide to buy it or not. And if you do choose to subscribe, I was an author or comicist, I should say, for the Wall Street Journal for a few years. My best, most popular Wall Street Journal articles, which are available by the way at the Wall Street Journal. You can sign up and become a subscriber there, so if you’re already there, you get it for free. Or you can sign up at my website at no cost and you’ll get all of my best articles from the Wall Street Journal.
Julie Clark: Awesome.
Joe Bauer: Very cool.
Julie Clark: Joe, I think that we should start with some at the SIC meetings, maybe some monthly awards for a healthy business.
Mike Michalowicz: Yeah!
Julie Clark: Redefining what a healthy business is, and giving, buying and giving our club members some of Mike’s books as a reward for operating healthy. What do you guys think about that?
Joe Bauer: I love it.
Julie Clark: So we record to this Podcast a few weeks out, or maybe even a month out before it drops, so if you’re listening to this, I don’t know what month it will be when you’re listening to this, but if you come to the next Seattle Investors Club meeting, you are going to be … We’re gonna have a bunch of these books here, or some, for those of you who have listened and are listening and can come and tell us healthy business stories, or your goals, on trying to achieve a healthy business. Redefined, a redefined, none of this BS guru stuff with however many deals you do and all that stuff. Joe and I will be working on some definitions. Maybe we’ll get Mike’s help here. We’ll get Mike Motor Bike’s help in helping us creating a healthy conversation that we can continue on with all our club members and all our followers of Seattle Investors Club and all our coaching. This has been awesome.
Joe Bauer: Yeah, and if you guys want to, if you’re not in Seattle and you can’t come to the club, check out SeattleInvestorsClub.com/38, and you can put that information that you have in the show notes, and maybe we’ll be able to hook you up there as well.
Julie Clark: Exactly. Awesome. So how do they find this today, Joe? SeattleInvestorsClub.com/38?
Joe Bauer: Yeah, you got it.
Julie Clark: Awesome. Well-
Joe Bauer: Cool.
Julie Clark: Mike, good stuff.
Joe Bauer: Thank you so much, Mike.
Mike Michalowicz: Oh, Joe, Julie, thank you so much. This was a lot of fun.
Joe Bauer: Yeah, absolutely. Absolutely. Like I said, guys, SeattleInvestorsClub.com/38, we hope you’ve enjoyed this, and I definitely, definitely, definitely recommend that you get the book Profit First, because it has absolutely changed our business. If you have any questions, let us know. All right. We will talk to you all later.
Julie Clark: Bye-bye.