Putting profit first with Michael Michalowicz

Speaker 1:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Agency Management Institute’s Build a Better Agency Podcast, presented by HubSpot. We’ll show you how to build an agency that can scale and grow with better clients, invested employees, and best of all, more money to the bottom line. Bringing his 25 plus years of experience, as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey, everybody Drew McLellan here with another episode of build a better agency. I love doing these podcasts and I love talking to my guests, but I got to tell you, I have had this one scheduled for a while and I’ve been looking forward to it for a long time. This is a guy who I have followed for quite a while. I have read every book that he’s written, and many of you have had me tell you to read his books and talk about his philosophies. I am really selfishly looking forward to this conversation.

I hope you enjoy it too, but I’m all for it. If you want to come along for the ride, you’re more than welcome to. Let me tell you a little bit about my guest. So, my guess is Mike Michalowicz. Mike, by his third 35th birthday, he had founded and sold two multi-million dollar companies. Confident that he had the formula to success, he became an angel investor and proceeded to lose his entire fortune. He started over again, really driven to find better ways to grow healthy, strong companies.

Many of you are familiar with his innovative strategy called profit first, which I talk about on a regular basis, a way for businesses to ensure profitability from their very next deposit forward. Mike is now running his third million dollar venture as a former small business columnist for the wall street journal. He’s a former MSNBC business makeover expert, keynote speaker on innovative entrepreneurial topics, and he has written many books, including Profit First, Surge, The Pumpkin Plan, and The Toilet Paper Entrepreneur, which business week, by the way, deemed the entrepreneur’s cult classics. With all of that, Mike, welcome to the podcast.

Mike Michalowicz:

Drew, it’s awesome. Thanks for having me, brother. I appreciate this.

Drew McLellan:

You bet. Let’s talk a little bit. Let’s dig right into, had a bunch of money and the next day have no money. What was that all about?

Mike Michalowicz:

That sucked.

Drew McLellan:

Yeah, right. That’s a bad day.

Mike Michalowicz:

Yeah, it’s a bad day. It’s a bad day. Yeah, if anyone tells you, oh, it’s a great awakening or something, it’s pretty painful, [crosstalk 00:02:32]. What happened to me is I had … Has been in the entrepreneurial space all my life. I’d sold my second company. It was two companies in a row I’d sold. My second one was acquired by a Fortune 500, and I thought I had the formula figured out that simply when you … If you want to achieve wealth, it’s an eventuality. You got to build, build, build. It doesn’t matter how much your business struggles, as long as you stick with the struggle and then exit out.

By the second I did this, I was like, oh, I figured it out. This is what you do. And so I did two things. I bought all the trophies in the world, the cars, moved into the expensive town, joined the club, because I thought, to should show off my wealth, it was really arrogance and ego. I’m embarrassed about it now, but that’s how I behaved. The other part was, I said, I’m going to become an angel investor and start all these different businesses and just pump them and dump them because this is where wealth comes from.

I had no right to be in the angel space. I had no clue what I was doing. I lost my money through ego, arrogance and ignorance. It took me only two years. I had become a millionaire when I was in my early 30s, I lost everything. My wife and three children, I had to come home to them to tell them, the guy who was meant to provide for the family was the guy who actually stole it all away. That moment was, oh, it was brutal.

Drew McLellan:

Yeah, I can’t even imagine. How do you go from that to the writing the books that you’ve written, to put in together the strategies that you now teach? What was the transition from sort of that confession that you had to make at home and looking at yourself in the mirror and saying, okay, maybe I wasn’t quite as smart as I thought I was, to what you’re now teaching today?

Mike Michalowicz:

Yeah. It took me. When that day happened, it was literally a day. It was Valentine’s Day of 2000.

Drew McLellan:

Oh lovely.

Mike Michalowicz:

Yeah. Perfect.

Drew McLellan:

Lovely.

Mike Michalowicz:

That’s the day I found out that … My accountant called me and said, Mike, you should declare bankruptcy. You’re done. I didn’t declare bankruptcy. I felt so ashamed of what I did. I knew I had to dig my own way out of this as I told my family. My daughter, literally, as I was telling the story, she was nine years old, ran to her room and got her piggy bank and said, “Daddy, daddy I’ll help us.” It was that desperate.

What that triggered is this turning moment, which was a two year turn. I went through actually depression. So, it didn’t get better.

Drew McLellan:

I’m sure.

Mike Michalowicz:

I went through functional depression. I’m not proud of it, I’m not ashamed of it. Meaning, I think a lot of people watching the show actually have experienced, maybe even yourself have experienced depression in some form. It is more prevalent in the entrepreneurial community than anywhere else in the world. I went through depression, which for me, was a of drinking when I should’ve been drinking, a lot of insomnia and no social situations where I put myself in. I was hibernating in my house, a rental.

How it turned was interesting. There was a moment, and I can’t remember the day, but there was a moment when I asked a question that I had never asked before. There’s one question that circulates all the time. They say, if you had all the money in the world, what would you do? It’s a good question, but there’s one assumption that is bad. The good question is, if you had freedom, what would be your passion, your calling, your purpose? What would you [crosstalk 00:06:01]? The fallacy or the flaw, I should say, in that question is, there’s an assumption that there is no financial constraints.

Meaning I could say my calling is to be a beach bum and drink margaritas on the beach in the Caribbean for the rest of my life. Yeah. Okay, that works. But the reality is we need to have a sustainable way of living our calling, or purpose, or desire, and it’s got to bring financial … Well, the question that came to me was, now that I have no money, because I’d blew all of the money, if I had no money, and I didn’t, what would I do with my life?

I think it’s the confluence of those two questions, if you had all the money in the world, you had total freedom, what would you do? But if you have to make a living doing it, what would you do? And once those answers are the exact same thing, that’s when you found, that’s when you truly found. I remember one time ago saying, if I had all the money in the world, I’d be an author. I want to just be an educator. I want to learn because I can teach. And the more I teach, the more I learn, and that just appeals to me.

But now I had no money. I said, what do I want to do? I said, I want to be an author and I can make a living doing this. I can really serve people and survive. Those two answers align, and that was kind of the aha, and I’ve set out and endeavored to do it. I’ve been doing it for almost 10 years now, nine years into it. Listen, it hasn’t been an easy journey. More and more people hear about me today because of the popularity of Profit First in particular. And they’re like, oh my God, you came out of nowhere. You’re an overnight success. You decided to write a book and look what you did.

And I’m like, that’s actually book number five, and each one’s been a fight, but I love it so much that it doesn’t feel like a fight. I’m in it because I love it.

Drew McLellan:

All of your books that are about running your business in a better, smarter, more profitable way. There’s incongruity in I lost everything I own, and now let me teach you how to run a business. So, how do you reconcile those two? How do those work together to be the wisdom that is in your books?

Mike Michalowicz:

Yeah. So, I found, well, I had success with my other businesses. I mean, they grew … Both of them were multi-million dollar businesses. If you wanted to find a successful, both of them were acquired. But there were certain elements I got wrong, but good timing played in my favor, or I could just survive long enough before someone else acquired it and fixed those bad elements. What was interesting was there were some things I was doing right, and I’ve now extracted with as worth. There’s many things I was doing wrong and I’ve investigated those.

I run a business today too, a new business, for many years now. What I’ve done is ever … As I write my books, I do two things. I say, what did I do wrong in my life? What did I do right in regarding this concept? Then I interview dozens, if not 50 or 60, entrepreneurs that have done it right, compile the common thing. Then the one thing I do that I don’t think was typical of most authors, but maybe, then I test on myself. Because I have an existing business, I’m writing a new book now. It’s not here. It’s called Clockwork. It’s not going to be out for another year.

I just finished the manuscript. I’ve been working on it for six years. I’ve been testing it for the last three years, in my business. Now I know for me what works, for these other entrepreneurs’ works. I got the proof for myself and now it becomes a book. I’ve done that, like Profit First, I started 10 years ago, right? In 2008, I started writing Profit First. This newest release just came out six months ago. I’m testing on myself, and only once I prove it to myself and can see the common thread, in all these other entrepreneurial businesses, do I think is valid enough to print the thesis.

Drew McLellan:

Yeah. It’s interesting because my business model is a little bit the same. So, I own an ad agency, but I also work with 250 agencies, and people say, well, why do you do both? And I’m like, my agency is like the lab, where I get to test things. Or people will tell me about a new tool or a new technique or a project management style. I get to test it in my lab before I tell other people that it works. Or I can say, well, here’s what had happened for us, so your mileage may vary, but blah to blah.

I actually think there’s credibility in the experimentation, but be that sometimes it doesn’t work. So, in my mind, the fact that you’ve built successful businesses and you’ve made mistakes along the way, which you’ve been pretty transparent about, and that you’ve learned from those mistakes, that’s actually what makes your books so pragmatic.

Mike Michalowicz:

Thank you. Thank you. I think you’re right. I remember the first iteration of Profit First, first I did it for myself. Then I wrote an article, I used to write for The Wall Street Journal, so I wrote an article about it and it got a lot popularity. Then started getting emails saying, hey, this isn’t working. It wasn’t working for me, but I didn’t even realize it, when I was putting profit into my business and allocating profit first, that sometimes my business would be under duress and I’d actually borrow, I’m air quoting borrow from my profit. I was actually stealing from myself and unwinding the system.

Drew McLellan:

Which doesn’t allow you to correct the mistake, right?

Mike Michalowicz:

You’re right.

Drew McLellan:

It allows you to mask the mistake.

Mike Michalowicz:

I was masking the mistake. Then I was like, oh my God, other people like, holy crap, I didn’t actually make the system, so I went through another iteration. I like that term, it’s a lab. It’s a living lab.

Drew McLellan:

Yeah. One of the things I love about Profit First is the idea that, and for those of you that haven’t read it, the idea is that in most businesses, and Mike feel free to correct me when I’m telling people what you wrote differently than what you wrote. The idea is, in most businesses, we pay all our bills and do all this other stuff. And if there’s profit leftover, we, as the owner, keep it. But, and as you have heard me preach a million times, when you leave too much money in your business, it gives you permission to make bad decisions, like keep more employees than you should or buy something that really you can’t afford.

The methodology that profit first teaches is that you set a percentage, and you really need to read the book, I’m clearly making it more simple than it is, but that you pull a percentage of your business out immediately and you put it in a separate bank account so that you, the business owner, are properly compensated for running a profitable business first, and then you in essence, have to run your business on the smaller plate, right?

It’s like an all you can eat buffet. If they give you a smaller plate, you eat less because you can only put so much on your plate, right?

Mike Michalowicz:

Right.

Drew McLellan:

If you are running your business with this smaller plate mentality, you will make smarter decisions for your business because you don’t have this big fat bank account that you’re in essence, you’ve already paid tax on that money in many cases, because you’ve left it in retained earnings, and now you’re just piddling it away because you’re making bad business decisions.

Mike Michalowicz:

Yeah. That’s the essence of the book. There’s subsequent steps to it, but it is the pay yourself first principle. We’ve all been told this in our personal lives. When you take home income, immediately reserve money for your future, hide it from yourself, live off the remainder, and sure enough, your lifestyle will adjust. I say, oh my gosh, this may apply to my business, and it does [crosstalk 00:13:34] business.

Drew McLellan:

Absolutely.

Mike Michalowicz:

Money flows in, you reserve stuff for your profitability, and you force your business’s lifestyle to live off the remainder. It does live off the remainder.

Drew McLellan:

Yeah, right. If your business has no profit, clearly, what that is saying to you is that you are choosing to make decisions about how you run your business that don’t serve the profitability part of your business. In many cases, especially in agencies, what that means is you have one or two too many staff people. And because you love them or you know that their kids in college, or whatever it is, and I get it, I’ve made the exact same mistake, you keep them on the payroll even though the business doesn’t justify them being there. The minute you take some of that money out of the pot and you don’t have it to pay them, now, all of a sudden, you have to learn how to run your business with the right number of staff, right?

Mike Michalowicz:

Yeah. It’s save the one or two people and kill everyone else off as a result. If the ship is sinking, we got to get rid of the things. Sometimes it’s not people, sometimes it’s living a lifestyle as an owner that’s beyond what the business can support. Most often it’s a combination of many variables, but it-

Drew McLellan:

Yeah, right. It’s not as subscriptions you don’t use anymore, it’s services. Yeah, absolutely.

Mike Michalowicz:

The funny thing ism when we do take our profit first, it forces our business to get very real about what money is truly available, because now we’re reverse engineering that profitability. [crosstalk 00:14:57] first, this is only what your business can survive off of. Now you have to make the decisions around that number.

Drew McLellan:

Yep. I don’t have any agencies that have implemented this system that are not running better businesses 12 months later, because you’re forced to run a business better.

Mike Michalowicz:

Yeah, totally.

Drew McLellan:

Yeah. There’s no fat that allows you to mask bad business decisions.

Mike Michalowicz:

That’s right.

Drew McLellan:

Yeah. If you haven’t read it, listeners, make sure that you grab it. But let’s back up a little bit. You had several books that led up to Profit First. What do you think are some of the … When I think about the first few books that you wrote, so The Toilet Paper Entrepreneur, The Pumpkin Plan, what were some of the kernels of that, that sort of set someone up to be a profit first business? In other words, there are some basic business principles in some of your earlier books that get a business ready to do profit first. What are some of those that our readers might find valuable?

Mike Michalowicz:

Yeah, so The Toilet Paper Entrepreneur is my first book. What I wanted to tackle in that book was the misconception of the importance of resources. The resources could be resources of cash to start a business, resources of a network of people, when you start a business that you have to have a network or education. We need to have education. What I realized is successful business launches actually are facilitated through the lack of resources because the lack of resources force innovation.

If I don’t have a network of people to buy from, I have to get really innovative and how to market and find them. If I don’t have the cash to get started, I got to get super innovative about how to get started with no crash, bootstrapping, it’s ultimate. My favorite though, is education. If I don’t have the education or the knowledge of the market, the only way into the market is by breaking the rules, because I don’t know the rules.

Yet, the irony is, it’s the lack of those things that prevent people from starting a business. Most people say, I’m not ready yet. I need more education. I can’t, I’m not ready. I need to save more money. I’m not ready yet because I don’t have a network out there that’s going to buy from me. I don’t have people to advise me. And they wait. The one thing that we’re spending that we can never recover is time. Time is the only non-renewable resource in the world.

That’s the one thing we have. What I try to argue in Toilet Paper Entrepreneur is start now, even when you have no resources, and ironically, it’s to your advantage not to have resources. The other book that I think the big kernel from the Pumpkin Plan, [crosstalk 00:17:43]. The big thing from the pumpkin plan was, once people had read the first book, The Toilet Paper Entrepreneur, people coming to me, some people were coming to me and saying, I got started now, I got to grow this thing. How do I grow it organically?

That was the big thing. Because even though in the news, we hear about the venture capital raises and all these different things that Facebook did or Google did, most businesses don’t live that lottery winning lifestyle. Most businesses are bootstrapped. I remember once I was at a conference with about a hundred entrepreneurs, some wildly successful recognized business names. Burt’s Bees was there, 1-800-GOT-JUNK. Another company makes cases called Speck, an expensive case for a phone, and there’s a VC who sat in front of a hundred people in this room.

And he said, “Of all the successful businesses in here, who raise venture capital?” And one hand out of a hundred went up. He said, “The reality is the most of you will never, have never, and will never, therefore you have to grow organically on your own.” In The Pumpkin Plan, what I did was I started researching out how to organically grow a company to explosive size. What I found is the parallel is ironically, colossal pumpkin farmers, the processes they follow, the foundational process, translates into the business process, and we can grow a wildly successful business, kind of following some of their principles.

Drew McLellan:

Hang on. You’re researching the business book, how in the world do you learn? I live in the Midwest where farmers are all around me. I don’t know the super secret of pumpkin farmers. So, how is your researching a book, do you go, oh, look at the interesting parallel between pumpkin farmers and business?

Mike Michalowicz:

Yeah. It’s weird. These parallels present themselves in the weirdest ways, but this one wasn’t so weird. I was working with a business coach years prior, and he said, “Mike, if you want to see organic growth,” he goes, “seek out organic growth.” And I’m like, “What do you mean?” He’s like, “Stop looking at your industry. That’s what people do.” He goes, “Well, look way outside.” He goes, “I challenge you,” and he just told me, “I challenge you to look at pumpkin farmers.” I’m like, what? He goes, “Do it. They know organic growth.” He goes, “Just learn from the outside.” So, I spent, ended up being a year, but a few days initially, and then ultimately a year of studying colossal pumpkin farming. Not a full-time devotion, but enough that it was a little bit on the odd side and started seeing with these guys do.

I’m like, oh my gosh. When we look outside, we’re outside the forest, the answers are so clear and obvious. I could see, oh my gosh, step one, step two, step three. That will work inside my firm. He just pointed me to it. Other times I kind of fall into it, but that one was pushed into my lap.

Drew McLellan:

Because I think when you’re looking for it and you’re thinking it’s all cooking in the back of your head, you sort of see it. But that idea of stepping back and out of the industry and being able to sort of clearly see what needs to be done, that’s what agencies do every day. We step outside of our clients. We’re not in the steel-making industry or the financial services industry. We, as experts, can step back and go, oh, well, here’s what has to happen.

I think sometimes agency owners go, I don’t know why they don’t see that. Well, because they’re right in the midst of it. Right?

Mike Michalowicz:

So true. It’s so true.

Drew McLellan:

Let’s talk about a little bit about that organic growth because every agency struggles with, other than referrals and getting more business from current customers, most agencies struggle with business development because the agency owner is often still in the business and so they’re tasked with the biz-dev responsibilities as well as the operational responsibility. So, what are some of the takeaways from the pumpkin farmer that we can apply?

Mike Michalowicz:

Yeah. I think one of the big takeaways was the process of, I call like growing or matriculating the strong sprouts. Here’s the analogy I found in pumpkin farmers. The ordinary pumpkin farmer actually focuses on weak sprouts because they’re in, what’s called the quantity game. The more sprouts I grow, the better, because in the fall season, when we’re recording this, in the fall season, that’s when you make your money.

So, you’re in the quantity game, the more sprouts you [inaudible 00:22:00]. You need to help the weak cause the strong can make it on their own. The interesting thing is the colossal farmers were the absolute flip opposite. When they saw weak sprouts, they actually pulled them out because they were stealing away nutrients and ditched them. The colossal farmer knows that a strong sprout has the most potential to become a colossal pumpkin. So, they actually assist the strong.

Well, I found the parallel in business, most businesses focus on the weak. The ordinary business says, who’s my weakest customer? As the owner, don’t worry, no one else worry about them. I’ll take care of them, that pain in the ass. They focus on their own personal weaknesses. I’m not a good salesperson, I’m going to go to some sales training, or I’m not a good accountant, therefore to get familiar with my books, I want to go to accounting and really get strong in this.

Well, the colossal entrepreneur, I found did the opposite. He said, what are my strengths? If I am a great presenter, I’m going to go out there and get the word out about, in the biggest way. Who’s our strongest customer? The weak customers, we’re going to actually remove, or at least not make our primary care point. It’s going to be our best customers. I, as the business owner, will cater to the best and therefore grow them.

I thought one of the big takeaways was identifying your best customers and amplifying them, concentrating on them, finding your best strengths in your business, amplifying that, always focusing on the strong and actually cutting away and carving out the weak.

Drew McLellan:

Yeah, that ties exactly to one of the things that I’m constantly teaching agency owners, which is you can’t be everything to everybody. Have core skills that you offer, serve verticals that you know super well and that you can have great strength in, but do not be a mile wide and an inch deep. Really build on your strengths and allow three or four of those legs support your stool.

Mike Michalowicz:

Just planning off of that, and I agree 100%, is the natural tendency of many entrepreneurs, agencies alike, focus on the weak customer. What I mean by the weak customer is a customer that calls up and they’re not happy with the service. They want the work redone. They won’t pay their bill. You redo the work and they still don’t pay their bill. By the way, I’m not even necessarily indicating these are bad people. They could be good people. They’re just bad for business, [crosstalk 00:24:20] for our business. Well, what happens is that triggers a response for many small business owners, agencies.

We cater to them more or say, oh my God, this customer is so upset. Let’s work harder. Let’s try more. We cater to them, and then an interesting phenomenon happens because we’re catering to the weak customer, that weak customer is surrounded by other people likely like them. Birds of a feather flock together after all. So, they call their friends and say, “Hey, you wouldn’t believe this. I don’t pay this guy, I get the best service in the world. You got to go here too.” And we start cloning our weak customers.

That’s the irony. If we’re focused on our best, the ones who pay us well, who we cater to, they will tell the other birds of feather they hang out with, which are great customers and will attract more great customers.

Drew McLellan:

Yeah. That is so true. So true. It all boils down to, the reason why we have a business to begin with is to make money. When I say that, I feel like I have to justify like, well, not an obscene amount of money. Well, yeah, I’m all for you making an obscene amount of money if you can do that. But we certainly are trying to run a profitable business, and yet many entrepreneurs struggle with being profitable. Why do you think that is?

Mike Michalowicz:

Well, I think there’s a lot of shame around that. I think profit means that you’re extracting more money than value you’re delivering because I don’t think people will judge value correctly. If I say I’m going to do this project for you, I’m going to charge you $100, and then I leave the scenario and there’s $20 left for me in profit, did I deliver you a hundred dollars of value or did I deliver you $80 of value? Because I kept 20 for myself. I think the problem here, Drew, is that people have a misperception of what value is. When you pay me $100, but I move your business forward, and as a result, if we just want to stay in the number space, I develop a marketing plan for you that generates $10,000 in new sales for you, did I deliver $10,000 of value or did I deliver $100 of value?

I don’t know. Or you probably delivered $10,000 of value and only charged you $100 for it. I think the reason so many people feel shame around profit, or that they don’t deserve it, it’s because they don’t understand the value of delivering. That they’re measuring it simply on a monetary transaction and therefore see profit as a negative thing.

Drew McLellan:

Well, I think about it as I’m trading time for money, right?

Mike Michalowicz:

Oh, [crosstalk 00:26:50].

Drew McLellan:

As opposed to, I am giving you my depth of expertise, my focus, my attention, and you’re right, I’m going to deliver something that’s going to get you two new customers, and the lifetime value of those customers is $200,000 a piece, and I only charged you $50,000 for that. That’s a bargain.

Mike Michalowicz:

Yeah. So, we got changed from the hourly concept to impact like what’s the impact you’re having? Build for the impact. Then the profit is a reward. I mean, think about it. It gives you two things. First of all, it gives you more finances to fuel your business. Now, I don’t consider that profit, by the way. I consider more money fueling your businesses as an expense, but that fuels your growth. Profit, I believe, is what gets distributed to the owners themselves as a celebration.

When you celebrate meaning, I don’t know, you go on an incredible vacation with that money, or however it’s spent, you get more invested in your business. You fall more in love with your business, which actually increases the value because you care what you’re doing. The opposite is happening for most businesses. They aren’t profitable and therefore they start resenting their business.

Drew McLellan:

I hate this. I’m so tired.

Mike Michalowicz:

Yeah, I’m so tired. So, your value that you’re delivering, the impact starts degradating. Profit changes our relation to a very positive relationship with our business and it brings about sustainability. Positive relationship with our own business and sustainability means greater impact. Profit helps us have impact, so it’s necessary.

Drew McLellan:

And it’s also the reward for taking the risk in the first place.

Mike Michalowicz:

Yes.

Drew McLellan:

Right?

Mike Michalowicz:

Totally.

Drew McLellan:

Yeah. I know you have this thing, we’re going to talk about the GAP’s Frankenstein formula, and I want to get into that in a second, but first, let’s take a quick break and then we’ll come back.

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It’s a little bit of coaching, it’s a little bit of best practice teaching and sharing. It’s a little bit of cheerleading sometimes. On occasion, you’re going to feel our boot on your rear end, whatever it takes to help you make sure that you hit the goals that you set. If you would like more information about that, check out agencymanagementinstitute.com/coaching. Okay, let’s get back to the show.

Hey, everybody, we are back. As promised, before the break, we are going to talk about the Frankenstein formula. Mike, what’s that all about?

Mike Michalowicz:

Yeah. I found there’s a formula in profit that is a total lie. It’s actually based upon GAP Accounting. GAP is the generally accepted accounting principles. The challenge I have with GAP, the problem I have a GAP is that we are told that sales minus expenses equals profit. It’s the foundational formula of GAP. Every everyone listening to show knows that to be a fact, but I believe it’s a total lie. I believe it generates a Frankenstein monster called our business, that we can never quench its thirst and hunger.

The problem with that formula is that, when profit comes last, we are told is insignificant. From a logical standpoint, sales minus expenses equals profit. Yeah, logically that’s a simple mathematical equation. The reason it’s a lie and fails us is when something comes last, from a behavioral standpoint, we believe it’s insignificant. If you or I got rushed to the hospital, and the doctor’s like, you got to change your diet, stop smoking, stop drinking. We don’t come out of the hospital saying, starting today, I’m going to put my health last.

No. So, starting today, I’m gonna put my health first. I’m going to care for myself. It’s human nature. When something gets first or comes first, it’s the absolute priority. It’s important. When something comes last, insignificant, it can wait. With the old formula, the Frankenstein formula, we’re told sales minus expenses, we’re told sales and expenses come first. So, most businesses say, I got to grow, I got to sell, I got to grow, I got to sell. I got to spend money to grow more. I got to spend money to sell more, and they get stuck in selling to literally cover expenses.

Most businesses today sell simply to cover its built and profit is ignored. Once a year, April 15th or whatever, if you’re a US-based company, you look at the invoice, you look at the end of the year statement that your accountant prepared and said, oh, it was taxes and I didn’t have a profit. Maybe I’ll have a profit next year. And we literally kick the can of profit down the road for 365 days. That’s why that formula is a Frankenstein formula. It is destroying companies. It’s making profit insignificant.

Drew McLellan:

Well, and that, I suspect, is the genesis of the Profit First book. So, if all of a sudden, hence the title, but also the practice of, if you have sales minus profit equals expenses, now all of a sudden, I have to manage to that money that I have to cover my expenses. It just kind of-

Mike Michalowicz:

That’s exactly it. It was funny, the first person I spoke to who was an accountant who saw the formula, the formula that you just said, sales minus profit equals expenses. I call that the Profit First formula. The first person that saw it, I aid, you know that’s exactly the same. So, what do you mean? That formula and the other form is exactly the same. You just switched the variables, and mathematically, it’s the same. I said, oh yeah, I realized mathematically it’s exactly the same, but behaviorally, it’s radically different.

Because now we’ve prioritized sales and profit. So, you got to sell services and you got to immediately extract profit. You got to sell your product, immediately extract your profit. Expenses, it’s only addressed after the profit’s been addressed.

Drew McLellan:

Right. Well, and it really, yes, mathematically the same, assuming that you are always going to have profit at the bottom. But what you said before is very true, which is, when it’s sales minus my expenses, sometimes I mismanage my expenses and dismiss things so that I have no profit.

Mike Michalowicz:

That’s right.

Drew McLellan:

But if I take the profit out first and I still pay all my bills, I mean, nobody’s going to go, “Oh, wait, on money, that’s fine, pay me next month.” Now I really have to run my business in a more efficient and effective way because I still have that responsibility and that obligation, but I’ve allowed … Profit is no longer optional. I think most businesses run a profit optional business.

Mike Michalowicz:

That’s totally true. It’s totally true. And they get frustrated, and then they say, I don’t know why I’m not profitable, because it’s optional. Because it’s optional. It’s 100% right, Drew.

Drew McLellan:

Yeah. People listening are saying, oh, okay, well, I get that. So, all right, I’ll start extracting the profit first. But I think one of the things I love about your methodology is you make it so hard, and maybe you learn this from your own lesson of when you were saying that you were doing it wrong for a while, but if someone actually follows the formula in your book, which is you put the profit in another bank account, by the way, in another bank.

So, you can’t just go online and go, I’m going to take, you know what, I’m going to take a little money out of the profit pot.

Mike Michalowicz:

Just for now.

Drew McLellan:

Just for now, and I’m going to put it over here, which mean you never pay it back. Basically, I’m just going to deplete my profit, but with your methodology, you make it so cumbersome to rob from yourself, that you really have to think about it. In that moment of, okay, I got to drive to the other bank or I have to write a check from one bank and deposited into the other bank, I think in that moment, you now have to justify the choice, which I believe makes a lot of business owners actually make better choices. Just the difficulty of it.

Mike Michalowicz:

Just the difficulty. It does. We’ve called it now the walk of shame. How it works is your primary bank, you have multiple accounts. The profit first system is all predicated upon natural behavior. I interviewed now literally thousands and thousands of entrepreneurs. I shouldn’t say interviewed, surveyed thousands and thousands in-person, online, and asked them a question. Do you do bank balance accounting? Meaning, do you look at your bank balance to see how much money you have and spend it or do you look at your P&L cashflow statement balance sheet and so forth? The vast majority revert to bank balance accounting. I said, okay, if the natural tendency is-

Drew McLellan:

Well, because it takes what? 30 to 45 days to have an accurate P&L for the last month.

Mike Michalowicz:

That’s right.

Drew McLellan:

In that case, I’m running my business based on two month old news.

Mike Michalowicz:

Plus, quite frankly, few people know how to read one. I don’t know how to effectively read those statements. My accountant says he does … He confuses the hell out of me reading those. It’s cumbersome and it’s delayed, but the bank balance is either money or not. And if I don’t have money, I don’t spend it. If I do have money, I can pay my bills. I said, okay, if that’s the natural tendency of myself and all these other entrepreneurs, what we’re going to do is set multiple accounts at that primary bank to act like the envelope system.

Money comes in, we divide it up. But then I realized, one of those envelopes was profit, I started stealing from myself when I couldn’t pay my bills, killing the whole system. But then I transferred that money over to a second bank, which no ATM card, no online banking, no starter checks, nothing. Literally, the only way I can withdraw my profits from there is to drive way across, in another city, I got to drive for 45 minutes to get this bank. I call it the walk of shame. I got to think real long and hard why am I playing this profit out? Am I pulling it out to celebrate?

That’s the right reason. Profit distribution is a reward for being an equity owner for taking massive risks. Or am I using it to pay operating expenses? I got 45 minutes to rethink this and say, I’m going to cut those costs, or not incur those bills, and letting my business run off of what it needs to run off of instead of stealing from myself.

Drew McLellan:

Yeah, so true. And you’re right. It is human nature. It’s entrepreneurs are overly generous to everyone, but themselves.

Mike Michalowicz:

So true. We would sacrifice ourselves.

Drew McLellan:

Yeah. Right. What I say to owners is I’ll say, okay, you know that you are overstaffed by one person. I want you to picture your kid holding some money that is supposed to go in their college fund, and I want you to picture taking it out of their hand and walking over and handing it to that employee because that’s what you’re doing. But we don’t think about it that way until we make it difficult, like with a system like yours, to really make sure that we are taking care of ourselves and our family, as well as everybody else inside our shop and all our vendors and all that.

I’m not suggesting that you don’t take care of your obligations or you don’t treat your employees well, but I don’t think the owner should be the after thought.

Mike Michalowicz:

I agree 100%. Because I think it only becomes a matter of time before we resent our business. It’s funny, so I do these webinars and, not webinars, these are live presentations regularly. I literally did one, two days ago, and I’m off tomorrow to do another presentation on profit first. One of my little secrets is I’ll ask the audience, who here as employees? And hands will go up. I’ll pick someone near the front row and say, what’s your name? It’s Drew. I say, Drew, tell me the name of your best employee.

You may say like, oh, it’s Sue. I’ll say, Drew, you’re lying to me. We don’t even know each other and you’re lying to me, because I can guarantee you are the best employee. I bet you work harder than Sue, I bet she worked longer hours, I bet you’ve sacrificed time with your family vacation. I bet you’ve done it for no money. That’s the definition of the world’s greatest employee. So, we need to change our relationship where the business starts paying you like the true person you are, which is the best employee.

Drew McLellan:

Yeah. That’s so true. So true. I know that you have spent a lot of time with folks in health and fitness, and that you’ve extrapolated some business lessons from those folks. Tell us a little bit about those.

Mike Michalowicz:

Yeah. A lot of profit first is fundamentally rooted in physical fitness, which those translate into physical fitness. One of them we already addressed, the concept of small plates. Here’s the parallel I find fascinating in physical fitness. The waistline for not just the US, but globally has doubled in the last 200 years. I mean, people, the obesity rate has doubled. Well, the interesting thing is plates, 200 years ago, were half the size of the plates today. It’s the natural propensity for us, 200 years ago, and today, fill up our plates and eat everything that’s on it. But since plates have doubled in size, so have our portions, so as our choleric intakes, so as our waistlines.

The real simple solution, if you want to lose weight, to actually get smaller plates at your house. Small plates allows you to continue to behave how humans have always behave. You don’t have to change, but now your proportions are automatically measured for you. That’s the principle here, of allocating, in profit first, the percentages first to the different accounts. We’re putting the appropriate portion to its rightful purpose before we spend a dime.

A couple of other principles, one principle is to eat your vegetables first. They found in physical fitness that most people serve all the food simultaneously, the steak, the potatoes, the vegetables. And if we simply serve vegetables first and only eat our vegetables, then when the meat and potatoes are served, we’ll have a more balanced meal. When it comes to our numbers, if we allocate our profit first, and so you were talking about this whole time, it’ll bring about automatic balance of what we can spend for operating expenses.

We need to portion out first. Then just one other principle I thought was easy, it was pretty interesting, was to get into a rhythm. In the physical fitness industry, even though most people eat three meals a day, they suggest we eat five small meals a day. Small portions throughout a day. We don’t go through these peaks and valleys of hunger. Well, in business, we often go through the peaks and valleys. A big portion of money comes in, we blow that money. And then we go into this valley of like, holy crap, we have no money, we’re so reactionary.

Profit first, we get into a rhythm of allowing money to accumulate into our income account, then we disperse it out to the other accounts, accumulate, disperse, accumulate, disperse. If you get into a slow rhythm, it forms a wave pattern and allows you to manage your money a lot less reactionary. And we also get to see the natural wave pattern of the income account. So, we got a sense for what our [inaudible 00:41:45] cashflow is.

If there’s an anomaly, it’s a little high, higher than expected or a lot higher, or it’s a little low or a lot lower than expected, we will notice because we’re used to the size of the waves that come in.

Drew McLellan:

Yeah. All good principles. When you combine those things, now you can start to see, and again, if you’ve read the book, this is repeat for a lot of you, in terms of this is reinforcing the messages, but if you haven’t read the book yet, it’s the mix of these metaphors that allows you to run a more efficient business and allows you … A lot of agency owners, they didn’t go into the advertising business or the marketing business or the web dev business because they love math.

I used to say to people, well, I went into advertising because I’m a writer. I didn’t do math. Then all of a sudden, I own a business which have now owned for 24 years, and I was like, crap, I have to do math, a lot of math. But the reality is that this simplifies the business. When you follow these principles of eating off the smaller plate and watching the ebbs and flows and the other things that you’ve talked about, these principles allow us to simplify the math. Now all of a sudden, instead of sweating payroll and other things, you’re going to know, on a regular consistent basis, that you’re running your business in a way that you can meet all your obligations without, by the way, you’re not taking a paycheck, which all of you have done at some point in time.

Or without you getting to the, whenever your country pays taxes if you’re outside the US, or April 15th, and you go, I have to write a check for $20,000. I don’t have it. Because I didn’t put it away. I didn’t allow for it, because again, I was doing what Mike said, which is sales minus expenses, and hopefully there’s something left. This completely changes it. And it takes so much of the stress and pressure off of running your business. Because now you’ve got enough. It’s an abundance mentality. That’s what I love about the book. It really encourages abundance rather than scarcity. For you, what’s next for you? What are we going to learn from you next?

Mike Michalowicz:

Yeah, it’s right around the corner. I just submitted my manuscript for my newest book last week, and what it is, is for business efficiency. It’s interesting, I’m getting feedback from readers of Profit First, and are saying, and it works there. We believe there’s now over 40,000 companies in the US alone doing profit first, and it’s probably more than that. This feedback comes in every day. Actually, as I sit in here, I can see the emails one, two, three emails have come in from readers, four emails have come in from readers while we’re sitting here, because in the book, I call out to readers. I’m like, if you’re doing this, tell me.

Well, I don’t know if there’ll be in these emails, but I ask people in response, say, it’s wonderful. What’s the next challenge you’re facing? And the next challenge is overwhelmed. Some of these businesses, hopefully they’ve read all of the stuff I’ve done or other books, but they’re marketing well and expanding well with the Pumpkin Plan and Surge as a marketing book. They’re doing well with profit first, are profitable, but they’re doing all the work. Now it’s all about organizational efficiency.

Like I said, I’ve been thinking about six years on this now. I’ve discovered that most businesses are trying to become more productive, but productivity is a brute force approach to getting results. There’s a better way and it’s organizational efficiency, which they choreograph dance to getting results, where you get all the elements of your business working in a very synchronized pattern to bring really powerful results. There’s some really simple ways of doing it that I didn’t expect to find, but I think we found them, and now it’s in a book, and it’ll be out next year.

Drew McLellan:

Awesome. That is awesome. Any last thoughts that you … You’ve got entrepreneurs from big and small sized agencies, listening to us today, any last thoughts for them or words of encouragement from the combat fields that you’ve lived in?

Mike Michalowicz:

Yeah. I want to go back to profit first because I think this is the opportunity. I think someone’s watching right now and they’re like, this is great ideas, but it is overwhelm. Michalowicz’s accounts and removing temptation, and oh my gosh, for