Today my focus is on Principle number one called The Small Plates Principle. First I want to share a bit of background information so all this will make more sense.
Going all the way back to the early 1900’s we find the GAAP formula. Now GAAP stands for Generally Accepted Accounting Principles and the basic formula for this structure is Sales – Expenses = Profit. This means we sell our product or service, then we pay all the bills and whatever is leftover at the end of the month, quarter, or year, we get to keep.
I’m here to tell you there is a better way for entrepreneurs to run their business. All you need to do is flip the equation to Sales – Profit = Expenses. This is the Pay Yourself First model. It’s the Profit First way!
But exactly how is this going to work? This is why there are principles associated with the model.
To explain how this first principle called Small Plates works, I need to tell you about Parkinson’s Law.
Parkinson’s Law states the demand for something expands to match it’s supply. A great example is a tube of toothpaste. When the tube is new and there’s a lot of toothpaste in the tube, we squeeze out a lot onto our brush and think nothing more of it. But when the tube is nearly gone we begin to get resourceful by squeezing or twisting to get even a drop of toothpaste on our brush. You see the ‘less’ amount in the tube causes us to automatically conserve.
The Small Plates principle is based on the theory if the dinner plate is smaller, we will consume less food. Likewise when translated to bank accounts, the less money in the account, the more we begin to conserve and pay attention to the balance.
With the Profit First model all the money flows into one account called the Income Account. We do not pay the bills from this account. Instead we divide the money by percentage and transfer it to multiple other accounts (or small plates) to hold the money for a specific purpose in your business.
There are 5 bank accounts. I already mentioned the Income Account. The other four accounts are for Profit, Taxes, Owner’s Compensation, and Operating Expenses. By funding the Profit, Tax, and Owner’s Compensation accounts first, we are taking our Profit First.
The percentages for each of these allocations and transfers is carefully calculated so there will be just enough in the Operating Expense account thus keeping the entrepreneur resourceful and frugal in their spending habits.
I’m always available for a chat if you have questions. Be sure to come back next week for Principle number 2!