A question we often get from new users is how to handle repayment of multiple debts within the Profit First system.
When you run your small business using the Profit First method, there are good reasons for everything that you do. The basis of this system is that you allocate money for profit on a regular basis, usually the tenth and twenty-fifth of each month. Doing it this way sets up a reserve in the bank and by doing this repeatedly you develop an excellent habit. The process moves on to better budgeting, management of cash flow, and cutting waste out of your business.
But many new Profit First users will ask, how can I do this when I have so many debts to pay? The answer is that first of all you treat your debts like any other expense! You will be able to pay down your debts faster if your business is more profitable. So, maintain the Profit First approach at all times, always allocate to profits, and follow this plan.
How to pay off debts in the Profit First System starts on the tenth and twenty-fifth of each month when you will pay all minimum fees out of the operating expense account. Then, after all the bills have been paid,allocate the remaining money in the operating expense account to pay off the smallest debt. The goal is to pay this debt quickly and then move on to the next smallest debt.
This way of paying off multiple debts actually has a name. It is called snowballing. That is because with continued use of this approach you will have more money available each month to pay down each debt, moving up from smallest to largest in succession. To the extent that you can transfer some debt to a lower interest rate (such as with credit cards) go ahead and do that as well. But, the best approach with multiple debts is to always pay all minimums, pay off the smallest debts first, and let the amount of money you can apply to the debt increase (snowball) along the way. If your debts are troubling you, follow this approach and imaging a snowball rolling down the hill, picking up more and more snow, ready to demolish all debts within its path!
Then, in the Profit First approach to paying off multiple debts, apply the bulk of quarterly profit distributions to make a more significant payment on your debts. Usually, we suggest that you use between ninety-five and ninety-nine percent of your distribution for this task. And, we strongly suggest that you use the remaining one to five percent to celebrate your success in doing such a good job paying down your debts. And, which debts do you pay each quarter? Again, the best approach is just faster “snowballing.”Pay off the smallest debt if you can or at least take a significant chunk out of it!
An unfortunate fact in the demise of many a small business is not that they have debts but that they simply run out of operating revenue. So, while you need to always pay the minimum on your debts, don’t pay off so fast that you have no operating revenue. Because, when you have a lot of debts, it may be difficult to get credit to replenish your operating cash! Use a measured approach to paying off your debts and you will get there with your small business intact.
Profit First helps protect you because when you use this method, you are constantly putting money into your profit account. But, more importantly, when you learn to use Profit First, you learn better budgeting and cash flow management. And, you learn how to reduce waste in your business.
When you have multiple debts, treat them as expenses and let your repayments snowball until they are all gone!
If you still have questions or are interested in implementing Profit First in your business schedule a meeting with a Certified Profit First Professional today!