Profit First: Don't break your watermelon
Note From Larissa for Donna… While Donna is away from the office to host Sooter Consulting's annual team meeting, I wanted to go back to Profit First. In his book, Michalowicz talks about a gardener who took care of his yard offered to clean his gutters. This is a perfect example of entrepreneurs taking a quick paycheck without accounting for the implicit costs associated with a new service. How do we expand our services naturally?
Have you ever wrapped rubber bands around a watermelon? If you haven’t, I would recommend going to YouTube right now. I want you to imagine your business like that watermelon, and every product you sell or client you work with like those rubber bands. This is how Mike Michalowicz, designer of the Profit First system, would describe “expanding your business too quickly.” Inevitably, we add so many rubber bands that our watermelon becomes another mess we have to clean. What if we were smarter, though? What if, for every three rubber bands, we added a reed to help combat the tension? What if we slowed down the rate at which we added rubber bands or even divided our rubber bands between two melons?
Obviously, our businesses cannot sustain themselves without new clients and services. Industries change, clients become bankrupt or leave, and sometimes we simply grow dissatisfied when our businesses are stagnant. We have to grow. However, the Profit First method asks us to carefully consider how we expand. Let's brainstorm together!
We are graphic designers working with local restaurants, and our art style takes inspiration from early 2000s graffiti. We are a little on the low side with our cash flow, and a new potential client comes to us looking for art. Except... this client wants us to do our art in Blender, a 3D graphics rendering tool. This client is offering us $2,500 to do this project in a week! We think to ourselves: Blender is open source, and we have the time to learn it. Why not?
Then we realize that our computer can’t possibly run Blender without frying our GPU. It’s very demanding… but that’s a lot of money. Surely we can just upgrade our graphics card as an asset for later jobs! It’s just $900! Then we realize that learning Blender is hard. We have to spend 12 hours a day learning to get the design out by our deadline. By the end, we spent 48 hours rushing this work out, if we finished the design at all. Now it’s time to take out taxes, pay our monthly fees—let's say $1,000 in total—and then pay ourselves! How much did we make? Oh, yay, we made $8.72 an hour, totaling $419 in net profit. Fantastic.
Now, you might be thinking, Larissa, that’s total hyperbole! The sad reality is that it's not. Business owners constantly fall into the trap of taking a quick paycheck and realizing they barely made a profit. Oftentimes, business owners are stuck working with a client that costs them money because that invoice pays rent. This is what a poorly thought-out expansion looks like, and it happens far too often because we don’t know how to properly plan for an expansion. So how do we expand intelligently?
Electronic Arts (EA) is one of the largest video game companies in the world. Oftentimes, their titles are projected to sell millions of copies worldwide and earn billions in return. However, making a video game costs a lot of money. Mass Effect 3, a title that sold 7 million copies, took 40 million dollars to create, and took years of development time, Because of the cost, it’s reasonable to assume that EA must have allocated funds to the project years beforehand. That is what we should be doing! When we want to add a service or prospect for clients that may have special requirements, we should be investing resources in it beforehand. If our graphic designer in the above example had previously spent the time and money learning blender, then they would have made a much higher return on investment. How do we do that? Well, that’s where the Profit First system comes in.
Let’s return to our graphic designer and apply the Profit First system. Because our graphic designer is smart, they have already been allocating income into a technology account to handle necessary upgrades. Already, we can eliminate $900 for that job’s expenses because it’s already been previously allocated. Even if we did nothing else, our net hourly income has increased four times. But let's say our graphic designer has an education budget they allocate every time they receive income. Instead of fiddling around for 12-hour shifts, our graphic designer can pay a professional to teach them Blender. We all know that professional training is quicker and overall better than being self-taught. Assuming a 4-hour class, our artist only needs to put 8 hours a day in to finish the project, for a total of 36 hours including the class. We went from paying ourselves 8.72/hr to 41.66/hr.
Remember that our allocated funding can’t be used for other expenses; when it’s allocated, it shouldn’t be usable income anymore. Because we have had the foresight to fund ourselves to provide new services, we are less stressed and make more money. And by using Profit First, we kept ourselves on budget because the money we had for operating our business was split into different accounts.
The next time we want to expand our services, we must understand that taking a quick paycheck costs us more than it earns. Instead, we have to be smart and slowly grow our businesses with well-funded decisions to provide us with the resources we need to succeed. In a way, we added reeds around our watermelon to keep it from bursting.
So if you need help keeping your watermelon from exploding, we are here to help.