By the time you have reached this point in this 4 part series on Profit Autopilot, you have learned how:
- To be reasonably confident of making a predicted Profit and paying ourselves a Salary.
- To be confident that we will have sufficient money to pay out Tax and at least break even at the end of the year.
This assumes that you have amazing willpower and do not spend the money that is ear-marked for Profit on something else.
We are going to make sure that you get this willpower automatically and that is where the Autopilot part of the Profit Autopilot comes into play.
NOTE: Video Available
There is also a 15 minute video on this topic
(you will need to be registered to view)
Profit “Piggy Banks”
You know what a “Piggy Bank” is; a place where you can park cash until you need it. Having loaded money into them, you can be confident you will have cash when needed, your stress over being able to pay bills, as they fall due, is greatly reduced.
This article shows you how to get peace-of-mind by setting up Piggy Banks for various purposes and how to calculate the amount to put away into them on a regular basis so that you have enough cash available when payments are due.
In addition to your main bank account, into which all Income gets paid, set up the following additional bank accounts (Piggy Banks):
- Operating Expense
You are going to use some of these accounts (Income, Operating Expenses and COGS) quite regularly, they should be in a bank with convenient access.
The others (Profit, Salary and Tax) you want to keep your sticky fingers off, any deposits in these accumulate until you need to pay their respective bills. To reduce temptation they should be hard to access.
Consider putting them in a different bank that you don’t use often and has other impediments like:
- Having to write a cheque rather than a digital transfer, you have to mail.
- Even better is to force yourself to get a bank cheque which requires you to go to the bank.
- Have more than one signatory to the account, all signatories have to agree on every withdrawal.
- Choose an account that does not send you bank statements, you do not see what has accumulated without some effort.
Dividing up the Loot
All money comes into your Income account.
Every two weeks (more on this later) you go to that account and transfer money from it to your Piggy Banks.
Because we transfer amounts fortnightly, the formula for the transfer is 1/26th of the annual amount required (52 weeks in the year divided by 2).
In step 2 of Profit Autopilot - the “Profit Focused Business Model” article we used a spreadsheet example which you should refer to now. All the mathematics is done for you under the heading “Fortnightly” in the spreadsheet (Columns D & J).
- The calculated Profit transfer is $2,462 (cell D13).
Over 26 fortnights this amounts to $2462 * 26 = $64,012 which equals our "Decided" Profit of $64,000 (cell D5).
- COGS (Cost of Goods Sold) average 20% of Income (cell C15). Each fortnight transfer 20% of Income to the COGS Piggy Bank. Over time, this should mean that sufficient money accumulates in the COGS bank account to pay the relevant bills as they fall due.
Transfer the fortnightly amounts in the following order, in case there is not enough cash to cover all of them:
- Remainder goes to Operating Expenses.
If you short pay any of these accounts, make a note to pay the shortfall in addition to the normal sum next fortnight. We pay in this order so that the most demanding “clients” (Tax Office) are paid first.
Initially, you may find that you have more bills falling due (especially if your business has not been running very profitably) than you have money to pay them. You may have to drag out payment terms to cover the shortfall. This will always be the case until you get the Residual Amount in your Business Model to a zero or positive amount. Until then, your business will never be able to pay its debts and give you a reasonable livelihood.
Under nothing but the direst circumstances do you ever take money from the Profit, Salary and Tax Piggy Banks at your safe haven bank to pay COGS or Operating Expenses. That is why we want you to make it hard to withdraw this money.
If the Model has been correctly calculated, and if your Residual Amount in the Model is positive, the amount of money in the Operating Expenses Piggy Bank account will mount up. The money will be available when it is needed.
Many Operating Expenses are “lumpy”. You may only pay insurance, tax accountant, vehicle registrations once per year but we need to save all year for that one annual payment. We do that in the Operating Expenses Piggy Bank account. Sometimes the expense comes before you have enough put away. This is the only time that you can make a draw down on Profit, but, make sure you repay it as soon as possible.
Putting The Transfers into Action
One thing that you can be sure of is that there will be variability in the amount of Income that you make and Expenses that you incur. We do not want to set the anticipated Profit and Salary so high that you find yourself periodically getting into negative territory in the Residual Amount due to these fluctuations.
It is far better to start your Profit and Salary fortnightly deductions at a comparatively low rate until your business stabilises and then increase them as the effects of lowering your Operating Expenses increase the positive Residual Amount.
Initial transfers are as follows:
- Use last year's data as a starting point and be pleasantly surprised when your Residual Amount allows you to pay yourself more Profit and Salary.
- Refer to the Historical data section (Column B) of the Business Model:
- Salary - divide $25,000 (cell B6) by 26 = $962 - put this amount aside fortnightly into the Salary Piggy Bank.
- Continue this for the remaining Piggy Banks as per the order above.
It is probably not a good idea to assume that suddenly your ability to pay yourself a Salary and a Profit will go up dramatically over last year. Continue until the available Residual Amount allows you to put aside the fortnightly amounts in the "Decided" column (Column D).
Planning for Taxes
In many Tax systems around the world, you will need to pay your Tax on Employees Wages, Sales Tax and Profit on a periodic (often quarterly) basis.
When these come up, take the money necessary to pay the bills from the safe haven Piggy Bank labelled Tax. If the calculations in the Model are correct you should have sufficient money available. Note that as your Income goes up or down, the Sales and Profit Taxes will automatically be recalculated under the “Annual” heading in the Model (Column J).
If your business has paid staff it is likely that your Tax Office requires you to make deductions from what you pay them and forward them directly to the Tax Office.
If this is the case in your country, then the amount of money that you must withhold for this Staff Salaries Tax should be added to the fortnightly amount that the Business Model suggests you transfer to the Tax Piggy Bank.
It is important to note that the Business Model does not calculate what should be set aside for Payroll Taxes, this is an additional amount you will need to get from your payroll system.
That way, when Tax does fall due, you have automatically transferred sufficient money to:
- Pay for Staff Tax deductions.
- Pay Tax on the Profits your company is making in the Quarter.
- Have money to pay any Sales Tax/VAT/GST that falls due in the Quarter.
- Pay any additional taxes that relate to your business.
If the Model is working properly, you should have sufficient money in your Tax Safety Deposit Box to pay the taxes as they fall due.
If this is not the case, you can draw down on your Profit Piggy Bank as that is part of its purpose.
However, it is vital that you then make a change to the fortnightly amount of Tax that you are putting away to ensure that you never have a Tax shortfall again.
Continuing to rob your Profit to pay Tax means that your Business Model is not correctly constructed.
There is a formula to estimate Tax in the Model’s spreadsheet, and you could probably leave that as it is. However, if there is a Tax shortfall in a quarter that you expect to continue for the rest of the year, you could simply divide the amount of the shortfall by ½ of the weeks left in the year (as we are working with fortnights) to give an additional amount each fortnight that you need to put into the Tax Piggy Bank.
This should mean that you are going to be closer to having the required amount of Tax in your Tax Piggy Bank when you get there. If you want to be very safe, you could add more than the shortfall that you had.
Why Bother With Piggy Banks
Parkinson’s Law (Parkinson's Law article) tells us that expenditures will expand to fill the money available. Unless we keep a firm eye on what we spend we will always find "something" that we can spend our money on.
Even if we have a budget, we often tend to spend the budget early in the year (“I just have to have a new computer. I will be so much more productive”) and so find ourselves short at the end. You can probably predict expenses reasonably well but there is always going to be uncertainty around your Income from unpredictable events. If you spend your budgeted expenses but have an Income short fall, you are still in financial trouble.
Perhaps even worse, and typically with Government Departments, they find they have a budget surplus in the expense item at the end of the year and frantically spend it so that they do not "lose it" in next year’s budget.
You could achieve the same thing as our physical Piggy Bank accounts by putting the amounts into a spreadsheet or your accounting system.
Unfortunately, numbers in a spreadsheet or bookkeeping system really have very little substance and you will find it very easy to move that money around because it is “just on paper". The idea of having separate Piggy Banks has been demonstrated, by those who counsel on setting up personal/domestic money management systems, to force you to make a conscious and physical effort to move this money around. This acts as a mental roadblock causing you to think "should I really be doing this?".
Bill Payment Routine
It is important to convert your fortnightly accounting cycle into a routine/habit so that you get used to doing it and it becomes efficient.
Consider making the fortnights in the second and last week of the month. That allows people who pay your invoices monthly to have enough time to deposit money into your Income account.
It is likely to be a good practice for you to develop a check list so that you tick off each fortnight that you have done all the necessary tasks. There are several tasks that you could add to this list that we haven't already discussed, such as, invoicing your clients for work completed.
If you outsource this cycle of events, having a check list of some sort allows you to be confident that your outsourced labour has covered all the necessary tasks.
An exception to the fortnightly payment cycle maybe if you need to pay your staff on a weekly basis. However, depending on the nature of your business, it might even be possible to pay staff on a fortnightly basis as well.
A likely by-product of this fortnightly routine is that you don’t waste as much time looking at your bank account to see if the money has come in and can divert that time to your income-producing job. It may also reduce your stress by only looking fortnightly.
Coping with Unexpected Events
As we have said several times throughout this article, there will undoubtedly be fluctuations in your Income and in your Expenses that are falling due.
It is important that you pay what you can out of the Piggy Bank accounts set aside for that purpose. It is also important that you do not cannibalise the COGS and Tax "Piggy Banks" to pay bills other than those because you will simply find yourself short when they fall due. They are "mission critical".
If you do find yourself short, you can draw down on the Profit account, especially if you are short on Income, because that is one of the principal reasons for having a safety Buffer built into the Profit account.
One time that you could tap into the COGS account is if an expense you are facing is a large one that is not re-occurring on a regular basis. For example, stockpiling inventory in advance of producing an order. Although this will deplete the balance in that account, because it is not a recurring expense, the shock will be short term. You should repay COGS from Overhead Expense as soon as possible to avoid a COGS shortfall.
Without doubt, your Income and Expenses will vary from month to month.
We discussed this in the previous article on building your business model but we cover it again here briefly as a refresher.
As these variations start to get some sort of trend - hopefully up but possibly down - we need to tune the Business Model accordingly.
You could do this each month but experience shows that there is too much variation monthly to be of very much guidance in the direction the business has taken.
One substantial Income payment that comes in at the end of the previous month or the start of the next month can dramatically impact a month’s Profit.
Do the following on a monthly basis by all means but consider the results to be indicative only. If each of the 3 months in the quarter worsens, you almost certainly have a problem. If results are up and down, you may only be seeing the normal variation in short term results, for example, months with more or less pay days in the month.
We suggest that, each quarter, you print out the quarterly results from your bookkeeping accounting system and update your Business Model accordingly.
All things being equal, you would multiply the most recent quarter by 4 to get the annual estimates. However, if you have a business that is very seasonal and you had a particularly bad or good quarter because of that seasonality, you may want to make a reality check. You may want to apply some common sense - not simply multiply by 4 - to how you predict your annual Income.
Check the Fortnightly Transfers under the “Annual” column (Column J) in the Business Model each quarter. As your business changes over time, you will need to change the fortnightly transfers to reflect the business changes. If you make more Profit, you Tax will go up for example. As you sell more, your COGS fortnightly transfer will need to increase.
Declaring a Profit
Here is the fun part!
Each quarter we will also look at the money that may have accumulated in your Profit Piggy Bank. One of the principle reasons for this Piggy Bank is to insulate you from short term drops in Income or increases in Expenses. It acts as a "Buffer".
However, on a quarterly basis we can afford to take some of the money out of your Profit Piggy Bank account and hide it away even more deeply.
Experienced advisors suggest that you consider taking one half (50%) of the Profit left in your Profit Piggy Bank and place it another Piggy Bank account which we will call your "Growth account".
This should be an account where you must think carefully before you take money out of it so that your Profit builds.
You can also consider using some of this money to give yourself a "treat" for having run the business so financially efficiently in the quarter. Although it is great to save money for future use, without doubt, it is also great to experience some of the pleasures of treating yourself on a quarterly basis for all your effort.
Profits to Multiple Owners
You may have multiple Owners in your business.
The proportion of the Profit distribution to these Owners would be subject to the owner’s agreement, but normally would be based on the percentage Ownership of the Company.
However, the Owners may have put in various amounts of Capital as Loans to get the Company started. You may have an agreement that the initial Profits will be diverted to reducing that Owner’s Debt so that all Owners are on an equal risk footing. The actual distribution is entirely up to you but it would be wise to have agreed in advance, as part of the modelling process, what that distribution will be so that you do not have a disagreement on the allocation of the distribution down the track.
In a situation where your business has more than one Owner, and one or more of those Owners forgo Salaries until the business is Profitable, we need a path to rectify that. This is a debt owed to the Owner who is forgoing a Salary that they might otherwise get.
This money might be considered a form of "sweat equity" where the Owner forgoes Income to match cash that is put in by other Owners. In this case, not much needs to be done except keep a measure of it. On the other hand, the Salary forgone by an Owner could be considered as a debt that accumulates and then gets paid from the quarterly Profit.
You will have two pots of money to feed your growth ambitions.
- The money that remains in the Operating Expense Piggy Bank account is money that is available to you for expenditure on growing your business. In our Business Model, this will be the amount that builds up in the Residual Amount part of the Model providing you have constructed the Model to have a positive Residual Amount.
- The money in your Growth Piggy Bank account could be used to stimulate growth in Income.
Any Profit sent back to the business in this way must only be for activities that will definitely grow the business. If that money is spent on anything else it is going back into the group of “Unnecessary” or “Reducible” expenses. This Profit is vital for growing your business and should not be squandered covering every-day expenses.
Typically these pots of money might be used for staff or machinery which take a while to become productive. By not incurring that expense until you have enough money to pay for it, you will be insulating yourself from a short-term cashflow drought caused by expenditure preceding Income in a growth spiral.
It is very likely that you have incurred debt in setting up and operating your business.
Such debt can come from several directions including the following:
- Your own cash contributions.
- Friends, family and related sources.
- Bank overdraft.
- Credit card.
- Bank loans.
Not all debt is considered the same and not all of it is necessarily bad.
It is likely that you will borrow money from a bank under reasonable terms and conditions and providing you can meet the interest repayments, this form of financing is quite a reasonable way of getting the capital for your business.
The worse debts are likely to be the ones that are either the most expensive in their interest rate (typically credit card and overdraft debt) and/or that which keeps you awake at night (typically money you have borrowed from friends and relatives).
What we want to set as an early goal in your Business Model, is to pay down any "bad debt" until you can get your business operating at a level that virtually guarantees you a Salary and a Profit. You then know that you have a sustainable Business Model and you can grow from that point.
Each quarter, you should be able to have a Profit Distribution from your Profit Piggy Bank. Rather than take a Profit, you can channel this money into paying the "bad debt" first and then into other forms of debt until you reach what you consider a sustainable level.
If you have an unacceptably high level of bad types of debt in your business, you may decide to keep your Salary Piggy Bank comparatively low and divert more money to the Profit Piggy Bank on a fortnightly basis. In this case, your Profit Piggy Bank figure will be inflated, and as this is directed towards repaying the bad debt, your bad debt will reduce as rapidly as possible. Once you have your bad debts out of the way, and increasingly can sleep well at night, then you can change the proportions of money that you direct toward the Salary and Profit Piggy Bank accounts to begin to boost your Salary Piggy Bank.
You may want to consider opening a hard to access Piggy Bank named "Debt Reduction" and transfer money to this account on a fortnightly basis from the Profit Piggy Bank. This is particularly useful if you plan to allow a company to direct debit money on a regular basis to reduce debt. It will guarantee that you have the money available for the direct debit payment.
As a psychological boost, experts suggest you start by paying off the smallest of the “bad” debts you choose. This gives you a comparatively quick victory and a sense of personal satisfaction and achievement that will inspire you to continue.
Mortgage Repayment Saver
Some debts, like a mortgage, are large and will run on for many years. Because of the impact of compound interest (see Compound Interest article), the amount you end up paying is much greater than the original debt. The faster you can pay off this debt, the less the compounded interest will be. One easy way is to speed up the frequency of payments. If they are presently monthly, for example, move them to fortnightly and pay half the monthly total each two weeks. As you will have paid 26 fortnights or 13 months, you have paid 1 month more in the year than by paying monthly. This little change will mean you have paid off the debt in 23 years instead of the original 30. Amazing!
Credit Card Interest
We often read somewhat romanticized stories of how the budding entrepreneur maxed out a dozen credit cards to keep the business afloat.
Credit card debt is terrible debt.
It usually comes with interest rates 3-4-5 times higher than loan debt; plus all sorts of late fees and other charges.
If you need some way to pay over the counter, replace your credit card with a debit card linked to the appropriate "piggy bank". That way, you live within your means or you can't buy the item in question.
Pay down credit cards as quickly as possible and then destroy most if not all of your credit cards and stay well away from that toxic debt.
Remove Auto Deductions
Over time, many businesses accumulate auto-deductions for various purposes like rent, interest, monthly gym fees etc.
As far as you can, you would be better to remove these auto-deductions. You will then have to consciously write a cheque or make a payment as they fall due. This will remove the number of surprises you get when an auto-deduction that you had forgotten about clicks in.
It also lets you have a reality check as to whether you really wish to continue with whatever the auto-deduction is for.
At the very least, you should move the auto-deductions to the appropriate Piggy Bank account so that you can better manage your money. For example, Interest rate deductions may come from a purpose made Interest Piggy Bank.
If you really have a lot of trouble managing credit cards, or have difficulty removing auto-deductions from credit cards, you might give some thought to cancelling that credit card.
This will make those taking auto-deductions contact you again to setup a payment system. This should be manual in so far as possible (at least in the early days) of your turn around, so that you can manage them better.
Use Auto Deductions
But you can also use auto deductions to your own advantage.
Most electronic banking systems allow you to automatically move money between your accounts each chosen period; say monthly.
Using this resource, you can move money out of the accounts you deal with regularly and into chosen "piggy banks" automatically. No forgetting and a pleasant surprise when you find the auto deducts have been quietly accumulating a nice little bundle for you in the "piggy banks".
Additional Piggy Banks
There is no real limit to the number of Piggy Banks that you can have.
If you find the process of setting aside money for some future significant expense event works for you, then we strongly encourage you to do it.
Many things that you need to buy for a business (for example, a new vehicle) are “lumpy” things. The cost comes as one big lump rather than over time.
If you have given serious thought to the steps that you need to progress your business, you can start to put money aside in those Piggy Banks so that it adds up.
Stress Test your Growth Plans
Let’s say you think you want to get a new Sales Person but are worried that the business can’t support it.
If you start taking that Sales Person's salary out now and depositing it in a Piggy Bank, rather quickly you will see what this does to the economics of your business.
In fact, it is the worst case because there will be no Income to offset this Expense. That is likely to be the case in many new hires for some period of time while they find their feet.
When your business appears to be robust enough to employ that new person, you have already set aside sufficient money to pay their first several months of employment when their productivity is low. You have built in insulation for an increased cost without offsetting increased Income.
If you think that it would take 3 months for a new Sales Person to become productive, then save money for 3 months beforehand to prove to yourself that you can afford them and then when you do employ them you have covered their pay for that 3 months and in fact continue to recover their pay until they become productive.
If you are in the position of having bank debt that requires regular Interest, we would encourage you to setup an Interest Piggy Bank. Each fortnight, whatever is the necessary amount to put aside for Interest goes into this Piggy Bank.
If your bank does an auto-deduction for Interest, as many do, then you give them the Piggy Bank account to do the auto-deduction.
In this way, you can be confident that there will be enough money to pay the Interest as it falls due and that there will not be any unexpected withdrawals from your main Operating Expense account at a time when you are hoping to have that money available to pay your other bills.
As your business begins to turn around and accumulate more Profit and provisions for Tax, this starts to build up in your Profit Piggy Bank.
Even though you are taking money out of this on a quarterly basis, it can still mount up. Because you want to keep this money indefinitely as part of your Insurance Buffer against bad times, you can expect to always have money in this account.
Most bank savings accounts have very low interest rates so you may consider taking some of the Profit out into a longer term Fixed Rate savings account that earns you a bit more money. Keep in mind though, you do need some flexibility in this account to meet any unexpected down turns so you should not lock the money away for a long period of time.
If you do set up a lot of accounts, you might want to look for low/no fee accounts.
In many industries, such as Construction and Professional Services, you may receive a substantial payment in advance to commence work and then receive additional staged payments throughout the life of the contract and finally the balance of the account once the job has finished.
This means that you will get Income in "lumpy" amounts into your Income account.
You could disperse that money to the various Tax/Profit/Salary Piggy Banks as it comes in if you wish but that does mean uneven sums of money coming into those accounts. We would prefer that things come in in a steady flow rather than fits and starts.
To handle this circumstance, you could have another Income account that accepts these large infrequent payments and which you draw out on a fortnightly basis the proportional amount that you would have earned in that fortnight and run that through your normal Piggy Bank system.
This sort of approach may also help to smooth out payments to sub-contractors who might want to be paid more frequently than you get paid as the main contractor. The Lump Sum Payment bank account could also divert a proportion of money to a Sub-Contractors Piggy Bank that ensures you have money in that Piggy Bank at the time you want it.
Ideally, you also want to have a payment cycle such that the person you are doing the work for pays you more frequently than you need to pay your subcontractors, otherwise you are going to need substantial cashflow to cover this aspect of your business.
It may also be that you raise outside money to fund activities. This would be very common with a Start Up Business for example.
When you raised that money, it is likely that you undertook to do certain things. You want to be confident that the money remains available to do whatever you have undertaken and doesn't get frittered away paying other expenses.
For this reason, you might want a Venture Capital Piggy Bank that you can transfer money from to your other Piggy Banks. Only transfer to where that sum of money's intended purpose is. This will mean that you extract whatever money might be necessary to, for example, buy a piece of equipment and transfer it to the Operating Expense account when that equipment is purchased.
If you choose to leave the Venture Capital in one of your main accounts, it will camouflage any looming problems in your business because your Residual Amount in your Business Model is artificially inflated by the Venture Capital money which may not be able to be used for many of the expenses that you are incurring.
Keeping the Venture Capital in its own Piggy Bank and drip feeding it by way of transfer into the other relevant Piggy Banks means that you do not fall into the trap of counting your money in the one bundle.
Review to Date
If we review where we have arrived at it is potentially quite an exciting phase for your future business operations.
- Built a Business Model that demonstrates to you your historical operation of the business, sets your "Desired" business finances and then gives you a path to achieve these "Desired" finances.
- Given you methods to maintain the level of discipline that is absolutely necessary for any business operator. We have shown you how to setup a set of "Piggy Banks" which take a slice of each fortnights Income. The money, for such expenses as Tax, is available when you need it.
- The combination of these two means that you can be reasonably confident that you are operating a business that can continue to operate without giving you any surprises when it comes time to pay expenses.
- The Business Model will also indicate to you whether you have any prospect of ever achieving the outcomes that you "Desire" financially. If the indications are that you can't, then it is time to consider changing your Business Model to something that might be more profitable or alternatively deciding that you will move out of the business altogether. In a matter of just a couple of hours of straight forward calculations building your Business Model, you have a very clear understanding of your business future.
- As you track your business over time, you will automatically be alerted when your expenses are becoming unreasonable again. There seems to be a natural law that Expenses will grow over time and/or if you have an unexpected cost. It may be a momentary weakness that causes you to buy some new thing that you may not have necessarily needed.
- By allocating money to Profit, we have set aside a "Buffer" against uncertainty which you can be certain will happen. There will be unexpected events that cause you to have less Income than you anticipated, alternatively there may be others that cause you to have more Income than anticipated. In either case, your Business Model will set aside money in a Piggy Bank.
- The Quarterly distribution of Profit gives you a way of paying down any debt that owners have put into the business and then distributing money in an equitable way across the owners for their own personal use as they see fit.
- If your business is well run and you remain disciplined about expenditure, the amount of money in the Residual Amount should increase. The Business Model tells you that you can afford to spend whatever the positive amount is in the Residual Amount in the forthcoming quarter and remain able to meet your debts as they fall due. This gives you a road map to the growth of your business. It is up to you to use that available "Venture Capital" to grow your business as wisely as possible.
This has been Part Three of the Four Part Profit Autopilot series.
Revisit the others at the following links or move onto part four:
- We begin with an introduction to Profit Autopilot.
- Then we look at building a Profit Focused Business Model designed to give you confidence that you will earn enough to pay you a Profit and a Salary.
- From there, we discuss how to set up a system of “Piggy Banks” to be confident of having cash for expenses when you need them (this article).
- Finally, we review what you have covered and introduce the next Profit Savvy projects which continue you on the path of building your profit.
We do not know your business and its environment so we can only offer general advice on what might assist you to grow the Profit for the business you presently have. You should always seek professional advice on specific matters only discussed in general terms here.
As discussed above, we cannot guarantee results in any particular period of time or amounts, we do not know your particular circumstances.