What is Profit First Personal Finance?

Do you feel like after you pay all your bills and life expenses there is nothing leftover for yourself? Well, the profit first method of personal finance may be the solution you didn’t know about. Profit first has you paying yourself first so you can reach your goals.

Of course, this sounds simple in theory, but in practice it can be difficult to achieve.

This post we will lay out the profit first method of personal finance and you can see if it may be right for you.

What is the Profit First Method of Personal Finance?

The profit first method was made popular in the bookHow do you do the Profit First Method?

There are 3 steps in the profit first method of personal finance.

1. Set up your bank account system
2. Pay off Debts
3. Save

These steps were created for a business and can be simplified a bit for personal finance.

Step #1: Set up Your Bank Account System

In the Profit First method, you set up 5 separate bank accounts for the system. The 5 bank accounts are:

• Income Account: Where your revenue goes before you allocate it
• Emergency Account: A separate account for emergencies. The profit first method recommends at least 8 months’ worth of living expenses with no additional income.
• Daily Expenses Account: This account gets allocated money to cover daily and/or non-recurring expenses. For example, food, clothes, or unexpected repairs.
• Recurring Expenses Account: Money is allocated to this account for recurring expenses. Items like mortgage/rent, utility bills, etc.
• Debt Payment Account: The money allocated to this account is to pay back debts. This last debt payment account is your remaining allocation after all other accounts are funded and you have taken your target profit.

In W2 jobs, many companies allow you to split your paycheck to numerous accounts. This allows you to allocate to all 5 bank accounts directly from your paycheck processing service. Otherwise you will have to set up reoccurring transfers between your accounts to ensure the proper amount of money is moved to each account.

There are many different budget rules and personal finance financial ratios that can help you allocate you money between these 5 accounts. The goal is to segregate your money so it is obvious what goes to expenses and what you are keeping for your profit.

Step #2: Debt Management

There are 2 guidelines for debt management in the profit first method. First, you want to get rid of costly bad debts like credit cards. Then get rid of all your credit cards except for a single, emergency case card. And second, Michalowicz recommends you pay from the shortest debt to the longest and the smallest debt to the largest.

Pay off Bad Debts & Get Rid of Credit Cards

Michalowicz’s book recommends trying to pay off and then close your credit cards. You can keep a single credit card for emergency use cases, but that card should have strict rules for use and a low credit limit.

The profit first method is strongly against bad debts and encourages you to avoid adding more debt. The number one priority here is to get rid of debt and avoid increasing it.

However, the profit first method doesn’t address the downsides of closing credit cards. For example, if you understand your credit score, you know that credit utilization and credit history are two major factors that go into your credit score.

Following the profit first method will result in a lower credit score and potential difficulty if you do need to take out a loan in the future. For example, a lower credit score can result in a higher rate when taking out a mortgage. You don’t want to be stuck trying to fix a bad credit score while you looking for a new residence.

The profit first method says to get fully out of debt before worrying about your credit score. I think you can do both at the same time.

Second, the profit first method doesn’t offer much for ways to efficiently eliminate credit card debts. The purchase to transfer method of credit card balance transfers can save you thousands of dollars while you work to pay off your card.

The profit first method is more aligned with the Dave Ramsey 5 foundations of personal finance in its anti-credit card stance.

Pay off your debts starting with the smallest balance and shortest maturity

The profit first method approaches debt payoff similar to how some businesses do.

• Focus on more immediate debts than longer-term ones
• Pay smaller debts before larger ones (Snowball Method)

In attacking your debts this way, the profit first method is set to help you build confidence with easier ‘wins’ before taking on more intimidating debts.

There are two schools of thought on debt payoff, the snowball method and the avalanche method. Profit first recommends the snowball method, but this leads to paying more interest and having debt for a longer time. I prefer the avalanche method where you pay your highest interest loans first, even if they have larger balances.

The higher the APR is on debt, the more it costs you over time. Paying off the highest APR loans first results in the lowest out-of-pocket cost to you.

Step #3: Save and Invest Your Money

After you have accomplished the first 2 steps, you are financially stable. Now it is time to save and invest your money to grow your net worth.

Profit first recommends various ways to invest your money.

It is important to have a goal, and having a targeted net worth can help you track your progress towards your goal. Targeted net worth is a method to compare your current net worth to a glide path that will help you achieve your retirement nest egg.

In order to properly calculate and track your targeted net worth you need to understand the time value of money and how to discount projected values.

Part of the profit first method is to allocate your funds twice a month from your income account to your investments.

The Final Word

The profit first method is an interesting way to approach your finances. I agree with the core message of taking a set amount of money to grow your net worth first is the best approach. The profit first method also targets your behavior. This is important because your personal finance success is dependent upon your behavior.

There are 8 core personal finance foundational principles to follow for success. And one of them is to prioritize your saving and investing. I believe this is a better framework since it doesn’t suffer from some of the subpar advice in the profit first method.