How to Apply Profit First to your Property Investment Company
‘Profit First’ is a business cash management system and best selling book by Mike Michalowicz. The aim of the system is to move away from managing your business finances by your bank balance through a system of holding multiple accounts which enable the business owner to ensure there is cash required to pay for expenses when they arise and to ensure that the business owner puts aside cash to enable them to fund their own remuneration. It also enables them to reward themselves for the risk they take in creating a business by being able to set aside profit. This article will explain the basic principles behind profit first and will inform you how to apply profit first to your property investment company.
Why Profit First?
Business owners will usually spend whatever money is in their bank account on running costs and then take the remaining cash as profit. This usually means that the remaining pile is smaller than it should be meaning that profit is eaten up by expenses. By putting away your profit first you effectively pay yourself and at the same time are able to budget the remaining cash for your operating expenses and taxes. This forces you to remember to pay yourself first and also to ensure that you budget.
What is the Profit First System?
The system involves setting up a number of bank accounts to manage cash within a business. The business owner then decides predetermined percentages and splits revenue based on the percentages and moves into the relevant accounts on a regular basis each month. The idea is that there will be an adequate amount of cash in the relevant account when it comes time to pay certain bills, for example corporation tax at the end of your companies reporting period. Also importantly is that the system ensures that the entrepreneur remembers to mark aside money for their own compensation (often overlooked by business owners) and to remember to think about profit which is set aside. This means that the business owner can be rewarded for their hard work and the risk that they take in setting up their business.
How does Profit First apply to a property investing company?
Property investing companies are quite unique in that they are typically run by investors who build up their portfolios alongside either a salaried income or from another trading business. This can mean that they don't actually need the property income to live off. The result is that the system can be simplified slightly involving less bank accounts. The main principles of the book will still apply. It is recommended that the following bank accounts are set up as a minimum for a property investment company:
Corporation Tax. The rate is currently 19% so suggest allocating (round up) 20% of sales revenue to pay corporation tax at the end of your reporting period. This will prevent you being caught out by a large bill in the future. If at the end of the financial year you find that you have more money set aside in this account than required then you should transfer to profit.
Operating Costs. Depending on whether you use agents or not, some maintenance costs may be deducted at source from your rental income. It is likely though that large scale maintenance such as replacing a boiler would not be covered by your rent. It is therefore important to put aside 30% of rental income into this account. This will mean that you have a contingency to fund larger repairs and to pay bills such as for accounting and insurance.
Profit. Assuming that you are not going to be paying yourself a regular salary as you don't need to live off your investment profits, you should send the remainder of your rent into a profit account. You can then look to extract this money in the future or, preferably reinvest it into buying new property when you have sufficient cash, possibly combined with personal savings or a refinance to buy another property. Money from remortgaging properties within the company should also go into profit and should be reinvested. Note that extracting profits from a property company in a tax efficient manner is an article in itself and has been covered separately in this article.
Note if you use Starling Bank then you don't actually need to create new accounts but can instead use the ‘spaces’ feature which allows you to create mini accounts to ring-fence cash but they still sit within the main bank account. This is a very handy tool.
Conclusion. Applying the profit first system will ensure you pay yourself first in your business and that you budget for key expenses such as corporation tax and operating expenses. Please remember though that there may be tax implications of withdrawing cash out of your business and therefore ensure you consult your accountant before you extract profit from the company. Now please ensure that you apply profit first to your property investment company.
If you would like to talk about applying profit first to your property business then please get in touch.
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