Do you worry that after everyone and everything else in your business is paid, there will be nothing left for you? Have you been taught to believe that the first several years of your business must involve constant financial struggle? Well, it doesn’t have to be that way!
Mike tells us his story of entrepreneurship highs and lows. After two early successes, he found himself in dire straights, not bringing in enough money to pay his bills and falling into depression. But it was these struggles that made him realize that there was a better way of running his businesses—a way that would ensure that he could take care of his family while his businesses would continue to grow.
The formula is simple, even if it’s not obvious. Mike breaks it down step by step, so that even the most skeptical among us will realize that immediate business profits are just a simple mindset shift away. He helps us realize that profitability in our business is already “baked in” and that by changing our habits, we can start extracting it TODAY!
And make sure you listen for Mike’s business-changing idea: start slow, let it grow.
Check him out, and subscribe to the BiggerPockets Business Podcast so you won’t miss our next show!
J: Let’s welcome Mike Michalowicz to the show. How you doing today, Mike?
Mike: I’m doing well, J. Thanks for having me. Hi, Carol.
Carol: Hi. Thank you so much for being here. We are such fans, and we love your books, and we are so excited to dig into them more and hear what you have to say, so thanks again for being here.
Mike: My joy.
J: Yeah, Carol knows that this is an interview I have been waiting a long time to do. I’ve been a big fan of yours for many years. I love your books, I love your outlook on business in general, so this is really exciting. But I know that we have a bunch of listeners out there that may not be familiar with you, so I would love to give them the opportunity to learn a little bit more about you, how you came to write your books. You’re the author of several books, including The Toilet Paper Entrepreneur, The Pumpkin Plan, and the one that we’ll probably focus most on today, Profit First. Can you give us a little bit of background as to how you became a business expert and author on all topics business?
Mike: Yeah, absolutely. My background is entrepreneurial. I’ve been an entrepreneur my entire adult life. What’s interesting is I had the blessing of building and selling a couple companies early on, had a Fortune 500 exit, I had a private equity exit, and… What’s interesting is not that. I think what’s interesting is what immediately came after it. I thought I was Midas. Everything I touched turned to gold, you know? And was chock full of arrogance, complemented with ignorance, and started a third business as an angel investor, sucked at it. I had no right to be in that space. I invested in disparate businesses all over the place that did not complement each other. Golden rule number one as an angel investor, don’t do that. And I wiped out all my wealth, my family’s wealth, everything, and I had to come home to my wife and three children and tell them that I wiped out our wealth. We lost our house as a result, we lost our possessions, our cars. Did not declare bankruptcy, but probably would’ve been the most prudent thing to do. I decided to dig my own way out.
Mike: I think the interesting part is that there’s that saying, “If you had all the money in the world, what would you do?” Which I dreamed one day, “Oh, I’d be an author if I had all the money.” When you have no money, there’s a complementary question saying, “What’s the vocation you want to do now that you have nothing?” And if the vocation lines up with the dream, well, that’s a calling to me. And I said, “You know, I want to be an author, and I’m going to find a path to be of great impact as an author, but also to make a living this way.”
Mike: And so, 11 years ago, that’s when this all went down, I became an author. One last thing, it wasn’t like the next morning, after losing all my money and telling my family I lost everything, it wasn’t like the next morning I woke up and said, “I’m an author now.” I became a drinker first, was super depressed, started to hit the bottle a lot to self-medicate, and went through about two years of functional depression, self-diagnosed, but a high-level performing depression, but depression nonetheless.
Mike: But it also became this turning period for me, that I didn’t really understood how entrepreneurship worked. I definitely did not know how to master profit. We’re talking about that today. Didn’t know about business efficiency, I thought you had to carry the business on your back. All these kind of misbeliefs. And every book I’ve written since has been to dispel my own misunderstandings about entrepreneurship. I devote five to six years research each book, so even though I produce books now pretty frequently, I have three more books in the works that I’m researching out right now that won’t come out for three to five more years.
Mike: And I hope to simplify entrepreneurship. In fact, that’s my mission, is to make entrepreneurship simple. My vision, if that’s different than mission, is to eradicate entrepreneurial poverty, this gap of perceived success and the reality of struggle. I want to close that gap by making entrepreneurship simple. So that’s who I am, I’m a full-time small-business author.
Carol: I love that. That is really great, and I’m very grateful that you were just really raw and transparent there and shared what happened to you, what you said, 11 years ago when you had to shut down your companies, and you lost your house, and you were in depression, and you were drinking, and so on and so forth. Because there are so many of us as entrepreneurs that I think we all go through similar things on different levels, right? And maybe not everybody to that level, but I think that we all go through those failures at some level, and unfortunately, on the outside, people just see, “Oh, what’s the problem? You’re running your own business, you’re your own boss, what’s the… How hard can this be?” Right? So, thank you for being so open and honest about just the reality of the journey that we all face together. I think that’s [crosstalk 00:05:20].
Mike: You’re welcome. You know what’s funny, Carol, to your point, is the outside world, the perception is so different than the reality. And this isn’t true just for the everyday entrepreneurs, but I look at these, the Inc. magazine, and the cover is Elon Musk or Sara Blakely, or whoever the person is today, and what disheartens me is we start to believe that is what entrepreneurship is, and to be successful, you better grow a billion-dollar company. If you haven’t, you kind of blew it.
Mike: That’s not the reality. I would consider those folks, as extraordinary as their success is, really, I think they’re lottery winners. They’re very smart people, they’re very capable, they have to have extraordinary talent. But also, they’re in the right place at the right time with the right message, and that played into their favor. I know countless entrepreneurs who I’d argue as driven, as devoted, as intelligent as the ones we see on the cover of the magazines, but their businesses may not become a billion-dollar organization. It may be a one million, or five million, or ten, or whatever. But I want to make sure that we attribute just as much to success, and not just what we see on the cover of magazines, but in these more ordinary businesses. They’re, to me, just as successful.
J: Yeah, and I think a large portion of that is we grow up revering and idolizing these billionaires, these people that we look at that have so much money, and I think a lot of us don’t realize it until we actually become entrepreneurs ourselves, before we start running our own businesses, that yeah, that’s great, those people have achieved tremendous success, but there’s a huge price to pay for that. And a lot of us get into entrepreneurship, we become business owners not because we want to make a billion dollars, but we… Because we want to provide for our family, because we want the lifestyle, because we want to be able to… In Carol and my case, we left our corporate jobs 11 years ago with the goal of being able to put our family first, never missing the soccer game, never missing the piano recital.
Mike: I love it.
J: And for us, we’ll never be billionaires, because honestly, I don’t have that motivation. I’d retire long before I was a billionaire. But the fact that I can run, Carol and I can run a business, and grow a business, and support our family, and put our family first, that’s the goal for us, and so I think it’s a really important message for entrepreneurs out there, or wannabe entrepreneurs out there, that becoming a billionaire, or the money in and of itself, isn’t necessarily the goal. Everybody has to think about what their goal is, and in many cases, it’s not the money.
Mike: You know, Sam Walton’s dying words, purportedly, was, “I blew it.” Because Sam Walton, as he passed away in his hospital bed, surrounded by family that he did not know, because he was working grueling hours, a wife that was there more out, I think, of convenience than for affection, he says… He looked at his family and said, “I blew it.” I mean, is that our definition of success, to work so hard that you leave a business behind that you’ve also ignored a family to grow? I don’t know. I don’t know. And it’s a choice, but if Sam Walton was indicating what he deemed a success, he was a failure in that regard.
Mike: I believe now that the right size business will find us. I did have an aspiration of having that billion-dollar company, but it was arbitrary. I was in my 20s, I started a business like, “I’m going to be a billionaire.” And I attributed a lot of value in a number. As I’ve matured, and hopefully as some wisdom’s kicked in, I realize a number is… That’s all it is, it’s a number. I think the greater thing we can do is have impact on others, our community, our environment, our world.
Mike: And I think we have the greatest tool at our disposal, which is entrepreneurship. I think it’s the greatest tool to effect change, beyond government, I think is entrepreneurship. And with that, I think the right size business can find us. I don’t know if… Maybe a billion-dollar business is in my future because that is the best way to be of service, or maybe it’s a few million, or I don’t know what the number is. But I do know that the right size business will settle in with me. And to know it is, am I having impact, am I experiencing joy? And those two components, I think, will define what the right size business is.
Carol: I love that, that’s great. I love that you define the success and the right size in those terms. So, in your whole overarching goal of impacting other entrepreneurs, in making sure that they are successful, in paving the way, in giving them the tools and so on, how are you going to help them, which led you to write Profit First? What is the whole overall thesis of this book, and how it lays such a different mindset shift for entrepreneurs so that they can be successful?
Mike: So yeah, money, as we know, it is a really important vehicle, and I am not… As I say, it’s important to have impact, and it’s not about size, I am not disqualifying the importance of profitability. Listen, I’ve been totally broke, and I’ve been wealthy, and I’ll tell you, wealthier is the better side, at least from my experience. It’s a little bit more fun, there’s a lot more flexibility, there’s no question about it, and there’s a lot less stress. So I believe that entrepreneurs need that.
Mike: Here’s the great irony, Carol and J: I would say everyone watching this show or listening in right now has started their business probably for one, probably two reasons. One reason is they’re doing something I hope that brings them joy. It’s something that they feel called to do, it’s a talent of theirs, they’re excited about it, so it’s the freedom of that experience. But the other element, often, is for financial freedom. We start our businesses to make money, so that we don’t have to worry about paying bills, so we can live life the way we define it.
Mike: Sadly, most business owners, the two reasons we start our business never come true. Many business owners are lamenting their business: “I can’t believe I’m doing this, I’m so exhausted from this, and I have no money. In fact, I blew all of my savings.” So, we’re impoverished, and we don’t like what we do. Profit First addresses the first element that we need to tackle. We need to get financial viability to a business.
Mike: Now, here’s the irony. I believe that almost any business that has some degree of recurring income, sales, like you’re making some sales, even if they’re sporadic, but you’re making it year-in, year-out, you’re making some sales, there’s profitability baked in there that we simply need to extract. I also believe that the formula we’ve been told on how we can be profitable is actually the thing hurting us. It’s not our inability to become profitable, it’s the formula we follow, which is sales minus expenses equals profit. It’s the foundational formula, it’s called GAAP, Generally Accepted Accounting Principles, it’s been taught for years, and it’s become so popular it’s in our vernacular. We call profit the bottom line or the year-end, all things indicating it’s the last consideration in the business’s financial formula, which means it gets unaddressed or ignored.
Mike: I mean, when something comes last, it means it’s insignificant. Like, you would never say, “Oh, we love each other so much. That’s why we put each other last.” Hopefully you’d never say that. Maybe when you’re pissed at each other, but otherwise, no. You don’t put your family last, you don’t put your health last. What’s significant comes first. So the foundation of the Profit First formula is sales minus profit equals expenses. Every time there’s a transaction, we take a predetermined percentage of that income that flows into the business, allocate it as profit, hide it from the business, and run the business off the remainder.
J: I love that. And here’s the interesting thing about that, is I went to business school, I’ve started businesses, I advise businesses, and the more I learn about business, the more I read in business, the more things get complicated. Every book is about, “Here’s how you can do things better. Here’s cash flow management, and here’s financial statements.” And the more you learn, the more complicated things get. And basically, what you’re telling us is, it’s not getting more complicated, it shouldn’t be about getting more complicated. It’s exact opposite, it’s about, how do we make this even simpler than we’ve ever thought about business? How do we make this more simple than accountants think about business, and more simple than other business owners think about business? Because ultimately, like you said, it’s about the profit.
J: So, now that we’ve agreed profit’s most important, and we want to put profit first, the question becomes, well, as a business owner, how do I do that?
Mike: Well, the simple thing to do is to not change yourself. That’s the key to this. So, Profit First is a behavioral-based cash management system. It’s not an accounting system. It complements or works with any accounting. It’s a cash management system. It’s basically, how do we manage the flow of money? And the simplest thing to do is to observe an existing behavior and then channel that behavior to get the outcome you want. In other words, don’t try to change who you are or how you behave. That’s actually very hard. Instead, observe how you behave and then channel to an outcome you want.
Mike: Classic example is this. If you want to exercise, and I now do regularly, I found the hack. I used to say, “Get up first thing in the morning and go work out,” and then it was raining today, I’m like, “Oh, I don’t want to go work out,” or it’s always a reason not to do it, until I did one thing that intercepted my behavioral path. Every time I get up in the morning, first thing I do is go into the bathroom. Go in the bathroom, I have sitting on the toilet seat my gym shoes, so now I cannot use my bathroom without grabbing and holding on my gym shoes, which is the first step, so I have to. So today, I went out and did my run in the rain. As much as I didn’t want to do it, the first step was done. At least I had the shoes in my hand. “Well, at least let me put them on. Well, now they’re on, I might as well go for a quick run, and whatever, get it done.”
Mike: With our finances, I’ve been studying I can’t count how many businesses, and how entrepreneurs behave. Most entrepreneurs, the vast, vast majority, do not use their accounting statements. They don’t read their income statement, they don’t read the balance sheet. In fact, many of them don’t know how to read a cash flow statement, and I’m one of them. I do not know how to read a cash flow statement effectively. And yet we’re told, “You got to know all those things to manage your business.”
Mike: What I found is most entrepreneurs follow a different path. Their walk to the bathroom is they go right into their bank account, they log in, they see if they have money, and if they do, they spend it, and if they don’t, they panic. It is what I call bank balance accounting: see if I have money or not. Therefore, Profit First, I set it up to intercept that path. We need to have accounts set up at our bank, so now, when you log in to your bank, you have multiple accounts indicating different purposes. We call it the Five Foundations.
Mike: You have an income account for your deposits. You have a profit account to pay the shareholders, the people that invested or started the business. You have an owner’s compensation account, that’s to pay what’s called the owner-operator, the people who work within the business, the owner that works within the business. Then a tax account that’s reserved for your tax liability. Talk about financial freedom, the biggest bill for almost every single business that I know is actually the tax bill, and yet we’re not prepared for that. We’re caught off guard. “Oh my gosh, I owe how much?” Well, the business can, regardless of the formation of business you have, the business can pay your taxes. There’s different strategies on how to do it, if you have an S-corp or C-corp, but it can. And then the last account is opex.
Mike: So what happens now, money flows into your business, we allocate money to these different accounts based upon percentages. And now you continue the same behavior you always have, you log in to your bank account, but instead of seeing one account and seeing if you have money or not, now you have multiple accounts that tell you the intended use of the money before you spend it, so you start controlling the use of those funds.
J: Not to minimize this, but it sort of sounds like what we teach our kids. You get some money, and you put it in your spending bucket, you put it in your saving bucket, you put it in your charity bucket, and you’re basically… That’s how we teach kids how to use their money and think about money, and basically what you’re saying is, we as adults, we may know business or we may think we know business, but a lot of business is just behavioral psychology, and we need to train ourselves the same way we train our kids to think about buckets of money in our business. I love that.
Mike: J, you nailed it. Nailed it. That’s exactly what this is. This is the envelope system. And the funny thing is, this methodology’s been around for eons. There’s books like Richest Man in Babylon, Think and Grow Rich, the modern versions, Total Money Makeover by Dave Ramsey. The books and this concept has been around for eons, of divide money up before it’s used so you know what it’s intended for, and you stay within the confines of its allocation. I’m just a guy who says this applies to business too, it’s not just personal finances, and we can [inaudible 00:17:48].
J: So, how about for those entrepreneurs that say, “Okay, great, I have five buckets, I allocate my money appropriately, but isn’t it really easy for me to just kind of transfer money from one account to another and steal it, and kind of go behind my own back?” I know this is a leading question, because you address this in the book, but there’s a lot of people out there who are thinking, “Yeah, I’ve tried this system, but it’s too easy to just kind of rob the cookie jar and…”
Mike: Yeah. Yeah, it totally is super easy, and therefore dangerous. You know, that’s when this system becomes a glorified shell game, when we start moving money to different accounts, but then we say, “Well, I’m not really using it for this, I’m going to transfer it here.” What I share in the book is there is two accounts in particular that we really need to protect from ourselves. One is the profit account, because profit, money we’re going to allocate in there, profit gets distributed to shareholders, but not daily, it gets distributed usually on a quarterly basis. So that money will pile up, and it happened to me very quickly. I started this 11 years ago, right? This was one of the first things I did after I started experiencing depression, was I knew I had to get my arms around the financials, so I implemented and started the first flavor of this.
Mike: Well, once I did it, money started accumulating, small amounts, but money was accumulating in my profit account. And one day, I couldn’t pay my bills, so I kind of looked around and said, “Oh, I got money in the profit account. Let me borrow from that.” And the second I did that, I never paid it back, I unwound the entire system. So I’d found I needed to protect myself from myself.
Mike: So, what you do is you set up some more accounts. Now, I’m always afraid of saying this because people start saying, “This is such overwhelm, there’s so many accounts, what’s my bank going to say, my account…” Don’t worry about this. The setup for Profit First can take maybe an hour, one time, one hour of your entire life, and the rest of your life will be consistent profitability. It is worth the investment of time and the iota of aggravation. What you do is you find a second bank. So, I work with my primary bank, I love them, I have those five accounts there. I set up two more accounts, I call them holding accounts, at my secondary bank, so I have a profit hold and a tax hold. When money gets allocated out at my first bank, I then invoke a transfer from bank one to bank two, because transfers can take three or four days, but once the transfer’s done, now it’s out of sight and out of mind.
Mike: The idea for that second bank is to make it as inconvenient as possible. So, what we did in our office, we actually used an online bank, so there’s online banking, which if you can avoid that, maybe that’s a good approach, so you don’t even see the numbers. So, I can’t log into it. We have one person here at the office, me, that has the password, another person who has the rotating code for the account. There’s this little thing you get that has numbers that appear every 30 seconds, new numbers, you enter your passcode and those numbers, but that’s with another person. So for me to access our profit account once money’s in there, it’s impossible unless the other person gives me the code. It’s like the nuclear system, you know, two people got to turn the keys simultaneously.
Mike: That money’s so inaccessible, I just don’t even think about it. I don’t even worry about it. I know there’s profit there, and I’m excited when it will come out to me as a shareholder in the future, but I work within the confines of what’s truly available. My lifestyle lives off of the owner’s compensation, because I’m an owner-operator, I work within my business, and the business’s lifestyle lives off the opex.
J: I need to point out something really quick. I’m sorry, I apologize for cutting you off, Carol. But I find this fascinating, because I know there are a lot of people out there who are saying, “Yeah, these five buckets are great in theory, I should definitely be thinking about my business that way, and I can treat my business that way, but I’m not a little kid. I’ve had a business for several years. I don’t really need to implement five buckets; it’s just a good way of thinking about things.” But here we are, you, the person that actually wrote this book, that has sold two companies in the seven-eight-figure range, that is building more companies, that advises businesses, and this is literally what you’re doing in your business today.
Mike: Oh, yeah.
J: You’re not taking shortcuts. So, anybody out there that’s listening, don’t think you’re too big or too mature, your business is too mature, or you’re too good to be using these techniques, because literally-
Mike: Oh yeah, we got a public company doing this now. Now, it’s a pink slip, it’s not like Ford, but we have a true public company doing this. We have over 300,000 companies doing this. It is a normal response to say, “This is too easy,” or “It’s too simple,” or “It’s too childish,” or “It won’t work for me.” I get it. I actually had that exact same skepticism. But being in business the 12 years prior to implementing the system, I was never profitable. I grew those companies and I sold them; they were never profitable. I was lucky, in retrospect, to sell those businesses. Selling a company’s a rare thing. So, profitability is what we need to achieve, and a little tip here, if you have a business that’s consistently profitable, the valuations, if you ever do sell the business, skyrocket because an acquirer wants a profitable business.
Mike: The shortcuts are a danger. So, of our 300,000 businesses successfully doing it, sadly there’s probably hundreds of thousands of businesses that have failed, and we know some of their stories. And one of them is trying to take shortcuts. They say, “You know what? I’ll do this in my spreadsheet. I don’t need to set up these multiple accounts. I’ll just track this in a spreadsheet.” Well, I just want everyone to know, you already have a spreadsheet, it’s called your accounting system. It’s a glorified spreadsheet. And actually, all this stuff is already tracked, it’s called the chart of accounts. So your business is actually dividing up the money, if you’re managing the accounting properly, into not just these five buckets, probably into 50 buckets, all different allocations.
Mike: So you already have that system, so the simple question is, how’s it serving you? Based upon your active use of your accounting system, are you profitable? And most people I talk to say, “Not at all.” And I say, “Well, how often do you use your accounting system?” And they say, “I don’t, I go to my bank and see if I have money or not.” That’s your natural pathway. So, if you’re not doing it in your accounting system, you’re not going to do it in a spreadsheet. Our natural path is, in the moment, particularly under pressure, log in to the bank account and say, “Do we have the money or not?” We need it there under those pressure moments. It needs to be right there, and it needs to intercept our patterns.
Carol: Very cool, and I love also how you’re getting as tangible and tactile as putting these other accounts in a place where not only do you have to physically go visit that bank if you wanted to access them, but also to even find out any specific information about them, you have to go through another entire person, right? Because you’re just like, “Uh, I don’t even want to let Mike Junior know that I even have to go down this road,” right?
Carol: So it just puts a whole ‘nother psychological barrier to even accessing that in the first place. So, what do you recommend to business owners for this profit bucket? What is that number? Is it like 10%, 20%, 30%? What do you recommend we allocate for that to build the business out?
Mike: Yeah, I suggest start slow and let it grow. So, of the businesses, we have lots of case studies around this too, the businesses that went in full throttle… So, in Profit First, the book, I specify different allocation targets based upon revenue ranges. We conducted a study of about a thousand of what I call the fiscally elite companies. They were industry agnostic, all different industries, these were the best-performing companies. And it’s everything from a small business, $250,000 in revenue or less, maybe a micro-business, to businesses doing $50 million or more, and we analyzed everything in the entire range.
Mike: And what we found is, when a business has not been historically profitable, they go in, they implement the system, it may say, you know, your target is 20% profit, so maybe you have a million-dollar business, you should be saving $200,000 a year, and paying yourself another $300,000, and reserving… Because now you’re taking $200,000 profit, $300,000 in owner’s compensation, another $150,000 or $200,000 or $300,000 in taxes, and the little $100,000 or $200,000 left to operate the business. If you’re a million-dollar business that’s never been profitable, and you make that abrupt of a change, that will destroy your business. Do not, do not start off with the endgame, the target.
Mike: Instead, we say, “Start slow and let it grow.” If you’ve never been profitable before, meaning the business has not given you a cash distribution, this is not an accounting profit… Listen, Enron was profitable until the day they went under, right? So, accounting, those numbers can be played with to some degree. I’m talking about cold, hard cash profit. If you’ve not taken out cash bonus distributions above some kind of salary distribution, and it’s been zero in the past, we’re going to start off with 1%. Start slow. And now, if $1,000 comes in, I’m saying take 10 bucks of $1,000, put it into a profit account. That’s 1%. You won’t even feel the impact, because you can run your business off $1,000, you can run your business off of $990.
Mike: But what will start happening is you’ll start having this confidence, saying, “Oh, there’s some profit accumulating. There’s actual cold, hard cash here waiting for me. I can take this money out.” Then, a month later, you may grow to 2% and 3%. And maybe it takes a year and a half, maybe it takes some businesses up to two years to go into a full implementation of Profit First at the full percentages, but if you start slow and let it grow, you’ll likely have success.
J: Yeah, I like that. And the other thing, by building up, every business is going to have different level of margins, and if you’re running a 50% margin business, it’s easy to put away 10% or 20% without killing your business. If you’re Walmart and you’re running a 3.5%-4% margin business, and you put away 10%, you’re going to be in trouble. So, kind of building, starting at that 1% and building up to a point that becomes natural [crosstalk 00:27:06].
Mike: Yeah, kind of like that concept of the right size business finds you, the right profits will find you. They’re inevitably much higher than most people imagine they could be.
J: Okay, so, reassure us here, because I know there are plenty of people out there who are thinking to themselves, “Okay, this is great, this idea of putting the profit away first,” but what about those business owners who are sitting here thinking right now, “I put away the profit, I now don’t have enough income to grow my business. I need $X to actually grow my business and hit my targets for next year, but if I’m putting away profit first, I have X times 50%. How do I grow my business?”
Mike: Yeah, that’s my favorite question. It’s the most common question I get, and I’ll share a case study around that in a second, I think that may bring some light to this. Here’s the fascinating results we found: that businesses that take their profit first are outpacing, on average, their industry contemporaries. Businesses that take more profit are growing faster than their contemporaries, which sounds confounding, like, “How could that be? They don’t have money to put back into the business.” Well, what happens is when you take your profit first, you have to be much more critical of your spend, because there’s less money to spend.
Mike: So then we start looking for what’s called true ROI. “Are we actually going to get a result?” A lot of people throw around the term ROI, “Yeah, return on investment,” and they just… They’re just playing games in their head. But now there’s less to spend, you can say, “If I put a dollar here, will it result in $3 in 60 days or 90 days or whatever?” So the measurables become much more targeted and specific. There’s the Pareto principle or the 80/20 rule, which basically says 20% of the activities you do yield 80% of your results. When you take your profit first off the table, you got to identify hard and true what those 20% are that are driving your growth, and then you concentrate your efforts there, and it facilitates faster growth.
Mike: Now, here’s from a practical example. I got a baseball card from a guy named Jesse Cole. He’s the founder of a baseball team, Minor League All-Star, not majors, and they said, “We want to thank you for Profit First. It’s changed our business and it’s changed our industry.” The baseball team, you got to Google these guys later, it’s called the Savannah Bananas. Best name ever. And they started implementing Profit First, and they said, “When we ran this, we really realized we couldn’t afford to operate our business the way we were. We don’t even know if we could afford the electricity for the scoreboard.” Right?
Mike: And so, I’m like, “Wow. You got to pay for that, right?” No. He says, “What it did is it forced our business to innovate. We realized that people were coming to our games mostly for entertainment.” It’s Minor League Baseball; the average game gets about 300 attendees, and so there’s very little flow. He says, “We can’t afford the scoreboard, so we cut off the scoreboard, and we went to the old manual system. We also realized that when it came to the games, people wanted the entertainment. We can’t afford the entertainers, so we’re going to teach our baseball players to be the entertainers.” And so, the first practice you have at a Savannah Bananas baseball camp is not how to throw better, how to catch better, it’s actually how to line dance on your first day.
Mike: Fast-forward, by implementing this, Savannah Bananas has become probably the most innovative baseball team you’ve ever experienced. They are extraordinarily profitable on a percentage basis, by far more than any baseball team, including majors. They’re that profitable. And they get 4,000 to 5,000 people at every single game. They’re the only team in history who sold out four consecutive seasons, every single game, packed seats. Not ticket sales alone, actual attendance sellouts for every single game. He, Jesse, pins a lot of it back to Profit First. First you focus on your profit, then it’ll reveal what’s truly available, and you must work within the confines of what’s available. The opportunity for growth is not in investment, it’s in innovation, breaking the rules, changing industry standards. And it was the lack of money that forced that innovation.
Carol: Very cool, and what I think is just fascinating about that is when you’re operating in those confines, that you can only spend what’s available and nothing else, what it’s forcing you to do, like the Savannah Bananas did, it’s forcing you to get innovative, creative, and really use the resources that you do have, which are human resources, right?
Carol: So you’re getting really creative, you’re doing different things that ultimately are going to surprise and delight your customers. They’re going to be that… You’re really building out that human connection, really building out that customer experience, so ultimately, you’re going to grow. So it’s almost, as counterintuitive as it is to do it this way, you’re growing your business in a whole different way by going down these different avenues, being forced to do it, and being really clever about it, right?
Mike: Yes, it’s often easier to spend our way to a solution, as opposed to think our way to a solution, yet thinking our way to that solution is far, far more impactful. Spending is just the easy answer. It doesn’t always bring the right answer either, right? We spend arbitrarily. So, by restricting the flow of money, we have to think more, we have to be more disciplined in making the right decisions, and then now money fuels it to explosive success in many cases.
Carol: Yeah, that’s really cool, because like you said, it’s so easy to just throw money at a problem. Every time, you’re just like, “I’ll just throw cash at that and see what happens,” right?
Carol: It’s not necessary. It’s the quickest and easiest, but not necessarily the best. I think that’s huge.
J: Yeah. So, what about business owners that have debt? What are your thoughts on debt and how we as business owners can handle debt, and how should we be thinking about debt differently than is common wisdom?
Mike: Yeah, so if you have debt, you’re not alone. The vast majority of business owners do have debt. I’m a big proponent for eradicating debt. There’s only very unique circumstances I think we can leverage debt to our advantage, but it’s a rarity. The first thing, we need a strong financial foundation, and it’s by eradicating debt. The process is this: The only way to eradicate debt is through profit. A lot of people say, “I can’t be profitable until I’m out of debt,” and the answer is actually, you must be profitable to get rid of debt.
Mike: So debt is, just to be on the exact same page, debt’s an expense we incurred in the past that we couldn’t or chose not to afford. So, we incurred it, we used money from another resource, friends, family, borrowed from the credit card company, whoever it is. Then, fast-forward to today, we only can pay off those past expenses that someone else has incurred for us by making more money than we’re spending today, which is profit. You have to make more money than you’re currently spending in order to repay the past debt, so you have to… That’s called profit. If you make more money than you spend, that’s called profit.
Mike: So, you need to implement Profit First if you have debt. What we do, though, in this circumstance, is as money piles in that profit account, we service the debt as best we can through our ongoing operating expenses. So, say I have a debt of $50,000, and the monthly fee to maintain that, that’s $500 a month, that’s the minimum payment. So, out of the opex account, we’re now paying the $500 or anything else we can scrap up. But when we get to their quarterly profit distributions, when we take that money out for shareholder benefit, the first thing, actually, is a majority of that money goes to whack that debt. So maybe $7,000 or $8,000 is piled up in that profit account. We’re going to take that, say, $8,000, we’re going to take $7,800 and crush that debt, and really take a chunk out of it, while we’re still maintaining it with the opex.
Mike: A little bit still goes to the shareholder. And this is an important but significant caveat, is the shareholder must still experience a reward. A lot of businesses, the business is simply paying off bills, constantly serving debt, and so forth, and the owner never benefits. Over a period of time, the owner starts to resent their business. We start to hate our business, like, “All I do is I’m selling to pay expenses. This is killing me.”
Mike: So we need to experience that reward, because there’s a dopamine response. So what we’re going to do is take the majority of the profit, crush the debt, a little portion of it goes to celebrate, so you go out for a nice dinner or whatever, and you repeat this pattern over and over until the debt’s fully eradicated. Once the debt’s fully eradicated, you’ve also built the profit allocation muscle. You’re allocating money toward profit, allocating toward profit. Now, in this case, all the debt’s been eradicated, so the next distribution, it all comes out to you as the shareholder, and that’s a glorious day. I’ve been there. That was my own method to eradicating my own debt. I had $75,000 of personal debt that I used this system to eradicate, and $300,000 of business debt I used this system to eradicate.
Carol: That’s huge, and I like what you just touched on there. I remember a little while ago, we were talking about this as the same stuff we teach our kids. You take it up to the next level as, this is kind of how you run your household, and here we are, we’re taking those same exact principles, when you’ve got that extra bucket, you push down all that debt as much as you can to pay it off. So again, it’s just really taking really commonsense principles and applying them on a more macro level to help you grow and help propel you forward.
Carol: So, I’m curious, all that said, what’s your opinion on retirement accounts and for savings for business owners, like through 401(k)s, IRAs, and so on and so forth? Where does that fit in? What’s your take?
Mike: Do it. Please, please do it. Max them out if you can. You know, what happens is, our lifestyle inherently will adjust to our net income, at least for most of us. I think it’s pretty much human nature not to be effective savers, and the reason, I think, is because of Parkinson’s law. Parkinson studied human behavior and noticed that as a resource expands its availability, we consume more. More time I’m given to complete a project, it will take me longer to complete a project. The more money I earn, the more I’ll spend, so my lifestyle will very quickly ratchet up to my income. Therefore, similar to Profit First, we need to intercept how much take-home I’m taking, take the profit out first, if you will, the retirement components first, so my lifestyle will go to the cap of what’s coming in at a net basis.
Mike: So, I just encourage… I have a 401(k) for one of my businesses here, I max it out every single year. We have a SEP for another one of our businesses, max out every year. I have a individual retirement plan I’m working on, max out every year. All those things come out first, and when I get money take-home, those elements come off first, and then the net income goes into my own personal income account, and then we allocate that using, interestingly, the Profit First system again. We allocate it out and live off of Profit First, but the home version, if you will.
J: That’s great. Yeah, reminds me when I got out of college, and I had student loan debt, and I set it up so that every two weeks when I got my paycheck, my student loan payment came right out of my paycheck.
Mike: Yes, smart.
J: I never saw it, never thought about it, and I remember it was six or seven or eight years later that one day, my paycheck went up by like $300, which, back when I was kid, that was a lot of money.
Mike: Hot dog. Yeah.
J: And so I remember at the time thinking, “Oh my God, I’ve got this windfall.” And I was very lucky, I had a friend of mine at the time who said to me, “You’ve gotten along for the last five, six, seven years without this $300 every two weeks. Why do you need it now? Take it and have it automatically deducted and put in a savings account somewhere.”
Mike: So smart. So smart.
J: And I did that, and it was actually the thing that got me to start thinking about money differently in my mid-20s. So, it’s just another example of that whole “out of sight, out of mind” Parkinson’s principle that is just so, so strong.
J: Okay, we have a final segment of the show that we call Four More. Before we get to that final segment, I do want to ask one more quick question. I kind of put it out to my social network yesterday, “We’re talking to Mike Michalowicz. What would you ask if you could ask?” And by far the biggest question was, what’s on the horizon? What are the next book or books coming out? So, can you tell us a little bit about what’s next? Because I’m excited too, honestly, I just want to know what the next book is. I’m ready to read it.
Mike: I thought the question may be, “Why the hell did Mike grow a beard?” That’s what I was expecting. But I’ll do the book one. The book, the next book is coming out in April 2020, so it’s still a little ways out, but I’ve finished the entire book. I submitted it to my publisher, and now it just goes… It’s a big publisher, it needs to go through their machinations, so it’ll still take a while. The book title’s called Fix This Next, and I believe this may be my pinnacle work. I believe this is the most important concept I’ve ever developed, even greater than Profit First, and I’m so blessed by its popularity.
Mike: The thesis of this book is I believe that the biggest challenge entrepreneurs have is they don’t know what their biggest challenge is. So, there’s this constant almost panic style of putting out fires and letting our email dictate our agenda, not our vision. So, with that thesis in place, what I did was I figured out a structure, a way for a entrepreneur to pinpoint their most vital need in their business at the moment. And those needs will change over time, but what’s the one thing I can do in this moment that will be the most impactful in moving my business toward that vision?
Mike: So, it’s a compass, if you will for businesses. By reading Fix This Next, you’ll pinpoint where you are, what needs to be addressed right now, and once you resolve that, you’ll go through the same cycle and find the next need you need to fix, and continue that on until you grow your business as quickly and deliberately toward your vision as possible.
Carol: Awesome, I can’t wait to read it. It’ll be awesome.
Mike: I’m psyched about this one, [crosstalk 00:40:33].
Carol: Yeah, it sounds like a great one. Also, why’d you grow that beard?
Mike: So, it’s called lazy. We’re entering the winter holidays right now, and right around Christmastime last year, I took a four-week vacation. It’s something I wrote about in my book Clockwork, the necessity for every business owner to disconnect fully for four consecutive weeks. So I’m on my vacation, and I was like, “I’m not going to shave for a little bit,” and then the stubble appears, and it starts getting a little bit longer. My wife’s like, “You know, it kind of looks okay.” And then once I had a full-grown beard, my wife is like, “I like that.” And if my wife likes it, it stays.
Carol: There you go, happy wife, that’s all it takes. That is the best answer.
J: Yeah, I started growing one a few months ago, and my wife looked at me and said-
Carol: Wife didn’t like it. Wife didn’t like it at all.
Mike: And it goes. And it goes.
Carol: [crosstalk 00:41:18].
J: I think it was more the, “Where did all that gray come from?”
Mike: I know, mine’s all gray.
Carol: All at once, like, what the heck happened? [crosstalk 00:41:25].
Mike: Yeah, definitely. I definitely, when I look in the mirror, I’m like, “Who’s the old guy?” I mean, it definitely is an aging thing.
J: Crazy, isn’t it?
Carol: Yeah, it is, it’s nutty.
J: Better than the alternative, as they say.
Carol: Yeah, absolutely.
Mike: Oh, I’m in. I’m in.
Carol: Okay, awesome, Michael. We’re going to move to the part of the show we call Four More, where we’re going to ask you four rapid-fire-style questions. You’re going to give us the first answer that comes to mind. And then for the more, you’re just going to tell us more about where we can connect with you and learn more about everything about Mike, okay?
Carol: Ready for the first one?
Carol: What was your first or your worst job ever, and what lessons did you learn from it?
Mike: I’ll tell you my first job, it wasn’t the worst. I worked at a dry cleaners, and I was the guy who would clean the pockets before the clothing went on.
Mike: And sometimes you’d find stuff that you don’t want to find. But other times, you’d find money. Here’s what I learned from that, was integrity. So, the rule at the dry cleaners was, if you found $5 or less, you were permitted to keep the money, but the second it was over $5, you had to call the owner. And so, the first time I pulled… You never wanted like five and change, right? You’re always hoping for singles. So I got $5.10, and I’m like, “Oh, I have to call the owner.” So I call the owner, and then the owner of those pants said, “Thank you so much,” and said, “I’m going to come in to pick it up.” And they came in, and they gave me another $5 and said, “Keep that money that’s in there, but thank you for your integrity in sharing that I forgot money in here. Here’s another $5.” And that was a realization that there’s a quick, cheap, cheating the system way to make a quick buck, but there’s a lot more when it comes to integrity, and sometimes we’re rewarded for integrity.
Carol: That’s an awesome answer. Thank you for sharing.
J: Love that. Okay, every week, I ask the same second question, but I am the cohost, so I’m allowed to change the questions, and I want to change the question this time because I’m looking… This is something I do. I always look in the backgrounds, especially I love seeing bookshelves in the backgrounds of our guests.
Mike: Oh, yeah, you see my…
J: I’m a big book fan, and I’m looking, and I see a lot of the same books on my bookshelf as you have on yours. So I want to ask, as a businessperson, as an entrepreneur, and as a business author, besides your books, which are all absolutely amazing, what is the best book out there that our audience should be reading right now?
Mike: Okay, I’ll tell you the best book, and you probably haven’t heard of it, and it is the book you got to read. It’s called Friction, by a guy named Roger Dooley. Now, Roger Dooley is an author of a book called Brainfluence. A lot of these books at the top level here for me are neuroscience, behavioral type books. I fell in love with Roger Dooley’s work, and he just released a book, Friction, I think three, four months ago.
Mike: What he explains is the biggest impediment to the progress of business is friction. The more difficult it is to get something done, there’s this exponential drop-off of people actually completing a task. So, how do you make things friction free? It’s a fascinating study and a very practical how-to in reducing friction, the biggest impediment to success.
Carol: Excellent, thank you.
J: Awesome. And I will mention you have my favorite book back there, besides yours, The Goal.
Mike: Oh, you… Oh. [inaudible 00:44:27]. You know something… And that’s a manufacturer’s book, that’s not [inaudible 00:44:30]… That is a bible, is what that is.
Carol: Absolutely, yes.
J: Whenever somebody says, “What’s the best book we’ve never heard of?” that’s the book I go to, because so many people haven’t read that, but need to read that book.
Mike: Oh my gosh, theory of constraints, Eli Goldratt. I had the privilege of interviewing one of his protégés, a guy named Kevin Fox, for a full day for my book Clockwork, and really dug deep into Eli Goldratt’s work. The Goal is his pinnacle book, it’s a must-read.
J: Yeah, agreed.
Carol: Yeah. Okay.
J: Sorry, didn’t mean to distract.
Mike: I love to geek out on stuff like that. I know you’re talking about Carol, but I liked it.
Carol: What’s the book, what’s the book? Okay, so Mike, what is the best piece of advice you have for small-business owners that you haven’t already yet mentioned today?
Mike: Probably to listen to wallets, not words. What’s interesting is, I used to be beholden to surveys, and interviewing clients, and asking what they want, but I found that clients and prospects know the social rules, and if I… If you tell me, “Mike, your business sucks,” it’s very difficult to say it to my face because it’ll cause conflict. It’s difficult to say it in a survey because you know you might get a call from me and my customer service department. So it’s better to say, “Things are fine,” and not do business with me. You can go on Yelp and slam me behind my back.
Mike: So, don’t trust people’s words nearly as much as you trust their wallets. They’re speaking the truth through their actions. Measure spends. See if you’re getting repeat buyers. Those are the people who love you, and people that are curtailing their spend, are not buying from you, there was an issue going on.
J: Okay, and question number four. I’m going to let Carol ask this one, because this is her very favorite question, and somehow we got out of order and I’m taking this, but I think Carol should ask this one.
Carol: I do like this one, because it just gives a lot of insight into people. So, Mike, what is something along the way in either your personal or professional life that you’ve splurged on that was totally worth it?
Mike: Oh, so I just splurged on a UTV, which is a all-terrain vehicle, or ultimate… I don’t know, it’s basically a ATV but side-by-side, so there’s a passenger next to you. We just took it out, we got it two weeks ago, and we already broke it. I took it out with my son. So, just to set the stage… You know, it ain’t cheap. I used Profit First, I pay… Everything I pay for is cash, by the way, so it was 13,000 bucks, so I was using, accumulating money for it, I waited for six cycles or six quarters to get this, so a year and a half. And we buy it, and I go out with my son, and we just hammer on this thing, and now it’s out at the shop getting repaired. I’ll tell you, if they got to junk that thing and it’s done, it was worth every single penny for that two hours with my son. He was laughing, we were high-fiving.
Mike: It was the best time I spent with my son all year or in years, so a good investment in that regard.
Carol: How old is your son? I’m picturing this, that sounds amazing.
Mike: Yeah, well, he’s 18, so he’s off in college.
Carol: Oh, how fun.
Mike: Came back for a weekend, and when he came in, I said, “Hey, I got a little surprise for you,” took him out back, and there it was sitting there, and I gave him the keys and said, “Let’s go tearing into the woods.” Behind our house, we have all these different trails and stuff, and we were back there for a good couple hours.
Carol: I just love the joy that is emanating from you as you tell that story.
Mike: Oh, it’s the best.
Carol: And it’s really heartwarming, it’s really cool.
Mike: It was the best. And it’s electric, too, so there’s no smell, no environmental impact in regards to pollution.
Mike: It was just… It was just a blast.
Carol: Really cool.
J: That’s awesome. Okay, well, that brings us to the more part of the Four More. Can you tell our listeners where they can find out more about Michael Michalowicz, where they can get your books, if that’s not obvious, and where they can potentially connect with you?
Mike: Sure. So, the starting point that I would go to is mikemichalowicz.com. There is a shortcut, J, it’s mikemotorbike.com, and the reason is because no one can spell freaking Michalowicz at all. It’s Polish. So, go to mikemotorbike, it rhymes, dot com, and you can get free chapter downloads for my books. I call them the impact chapters. It’s not the fluff, it’s stuff that’ll get you results. You can get… I’m a blogger, podcaster, I used to write for The Wall Street Journal. All that stuff’s for free. If you want to pick up a book immediately, anywhere books are sold. Amazon’s probably got the best price, but you can go to Barnes & Noble’s or your local bookstore, and the book will be sitting there waiting for you.
Mike: But to get started right now in this moment, mikemotorbike.com, and click on Get the Tools. All this stuff I shared with you, including the free chapters, all of that you’ll get in an email, one single email, all to you immediately.
J: That’s awesome.
Carol: Awesome, thank you.
J: Carol was a [Dombrowski 00:50:02], but luckily, she married into a Scott, so…
Mike: Oh, I feel your pain.
Carol: Yeah, you know.
Mike: Yeah. Yeah, my wife [inaudible 00:50:10] equivalent of a Scott into a Michalowicz, the other way, not easy.
Carol: Yeah, the other way around, it’s tricky.
Mike: Not easy.
J: Mike, this was absolutely amazing. I am thrilled to have finally gotten the opportunity to chat with you, and I am looking forward to having you back when the next book comes out, and the one after that, and the one after that, and the one after that. [crosstalk 00:50:28].
Mike: I would be honored, J and Carol. Thank you.
Carol: Can’t wait to talk about Fix It Next. Thank you so much for being with us. We’ll chat with you next time.
J: Absolutely, thanks again.
Mike: Take care. Bye-bye.
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