02/09/2024
WHY GAAP ACCOUNTING IS THE EQUIVALENT OF TELLING YOU TO JUMP OFF A CLIFF AND FLAP YOUR ARMS
I started learning the "Profit First" financial method last year when working for a local accounting company and was amazed that its fundamental teaching is very similar to the "Dave Ramsey" envelope system for managing your finances.
In a nutshell, businesses have been relying on a traditional GAAP method of growing profitability that states: Sales - Expenses = Profit. Essentially, as Mike Michalowicz states in his book "Profit First - Transform Your Business From a Cash-Eating Monster to a Money-Making Machine", it is a "crusty, bifocal-wearing, old-person-smelling formula" that tells you to sell as much as you can, then pay your bills, and what is left over is profit. And there lies the problem - "Cliff, Jump, FLAP-FLAP-FLAP, Splat."
As Mike explains, that old profit formula (GAAP) creates monsters of businesses - HUGE, cash-eating monsters, that wreak financial havoc and destruction at every turn: empty your bank account, wrack up your credit card debt, incur "operating fund" loans, and the more you "sell", the more your ever-increasing list of "must pay" expenses grows. You work sunrise to sun-up, yet that "monster" looms relentlessly, eating up your time, stealing your sleep, and destroying your entire world.
I will be the first to admit that I have followed the "crusty, bifocal-wearing, old-person smelling formula" my entire life, both in personal finance as well as in my own business. My wake up call came with an introduction to "Profit First" by a former employer, at which point there was a blinding light that was not, for the first time, an oncoming train but a cosmic explosion complete with angelic singing! When you spend your entire life, be it working for others or working for yourself, you follow the old 1900s teaching: go to work, collect a paycheck, deposit your paycheck, pay all of your bills, and then set aside savings from what is leftover. The problem arises from the fact that rarely are there any leftovers from which to establish a savings account, much less give you any wiggle room for spending anything on yourself.
Small businesses are not the backbone of the economy. As Mike puts it, we ARE the economy! Not one giant, multi-million dollar company exists today without the initial foundation of a small business. And while we assume that those multi-million (and multi-billion) companies are turning a profit, the truth is that it is very difficult to find a "profitable" business - most are just covering their monthly debt while accumulating massive debt. We have been programmed to believe that "bigger is better", yet the next big sale or customer or investor realistically results in a bigger "cash-eating" monster because of our assumption that with hard work and sacrifice, at a certain point all revenue will yield a profit.
Logically, GAAP makes sense - sell as much as you can, spend as little as possible, and pocket the difference. It supersedes our natural behavior and convinces us that "bigger is better", which drives us to try to sell our way to success in a relentless cycle of chasing after every shiny object disguised as opportunity. "Cliff, Jump, FLAP-FLAP-FLAP, Splat." And when you survive that 10,000 foot fall, you'll be looking to hire an accountant certified in GAAP just to understand the financial model in all of its overwhelming complexity, move some numbers around, post some stuff in different accounts, make the numbers look different, and print you out a report that lists a number as your "profit" even though you haven't got a dime in your bank account to show for that profit (think Enron)! GAAP is a system for understanding all of the elements of your business, NOT for managing cash!
"Profit First" defines profit as something that cannot wait until tomorrow. It is NOT an event, it is not something that happens at year-end or the end of your five-year plan. Profit must be baked into your business and happen now and ALWAYS, every day, every transaction, every moment. Profit is a habit that follows a logical formula: Sales - Profit = Expenses.
If you want healthy, sustainable growth in your business, and even in your personal life, you need to set aside a percentage of your profit FIRST and then determine what expenses you can afford. Figure out what makes profit and dump the things that don't.
Michalowicz, M. (2017). Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine. Penguin Books.
