You ever find yourself in a vicious cycle of having little to no extra cash after all of your expenses? It’s almost like the world knows exactly how much it can squeeze out of you. The truth is, it isn’t an accident. It all ties in with a simple principle called Parkinson’s Law. This law states, “work expands so as to fill the time available for it’s completion.” In finance, that simply means expenses increase to take up any available income.
When you think about it, it makes perfect sense. Get a promotion, and you buy a new house or car. Find $100 on the ground, and you spend it on those shoes you have been wanting. Lenders take advantage of this too by stretching your money into “manageable monthly payments.” It is a hard trap to avoid due to social pressures, but it is avoidable.
There is a fantastic business book called “Profit First” by Mike Michalowicz that I base a lot of my thinking on. Most of it’s principles for business can be translated into personal finance. One of the main ideas of “Profit First” is to flip the script on the traditional accounting equation of (Sales – Expenses = Profit) and instead do (Sales – Profit = Expenses). The thought behind this is to put profit before expenses, and challenge you to really figure out what expenses are necessary.
My favorite overall takeaway from the book is how he teaches you to organize your bank accounts. Instead of keeping all of your money in one account, split it up into 4 or more accounts that serve different purposes. This allows you to see where you truly are financially in real time. For personal finance, you might want an Income, Expenses, Fun Money, Vault, and a Debt Crusher OR Investment account. Let me explain what each account’s purpose is:
Income Account – This account is solely for income. This could be from your job, FB Marketplace selling, money from grandma, etc. This account is used to disburse into your other accounts. Make sure your bank allows you to hit a zero balance with no fees. You will be moving money out of here.
Expenses – This account is for any recurring expenses that you have. It could be mortgage, car payment, gas bill, phone bill, etc. Make sure all of the expenses on auto draft are coming out of this account.
Fun Money – This is the money you use for personal pleasure. Going out on the weekend, eating out, or updating your wardrobe. Spend from this account with no guilt. Set up a debit card to use that takes funds directly from this account.
Vault – The vault is a cool word for savings. This money is a safeguard in case anything happens that causes you to be incapable of paying bills. The goal is to have 3 months worth of expenses saved here.
Debt Crusher OR Investment – If you have debt, this account ensures that you are setting aside extra money to crush that debt. Tip: don’t add any extra debt, it doesn’t help the process! The investment account is the goal here. This is the business “profit.” Congrats, you are making a solid effort to multiply your hard earned money at this point!
Bonus! You could also do an account for specific savings of a large asset like a car.
Why in the world would you go through all this trouble of making these accounts? Couldn’t I just theoretically do this on a spreadsheet? True, you could make a nice spreadsheet laying everything out for you. The problem is you aren’t going to pull up your spreadsheet every time you make a purchasing decision. In fact, it will be forgotten and you will revert to Parkinson’s Law and base your purchases on what you see now in the bank account. This system allows you to see a full financial picture EVERY TIME you log into your bank account.
Remember when I said to create an Income Account and use it for cash disbursements? Let’s dig into how to disburse. You are going to want to do an income and expense analysis to see what percentage of your income is going towards expenses. While you are looking deeply into your expenses, do yourself a favor and eliminate anything you don’t need (there could be some recurring payments that you forgot about too).
After trimming some expense fat, that will be your starting allocation disbursement. For example, if you receive a pay check to your income account for $1000 and your expense percentage is 75%, you will move $750 to your Expenses account.
Tip: When naming your accounts, put the allocation percentage next to it (Expenses 75). That way you don’t forget when moving money.
Now it is time for you to figure out your other allocation percentages. My advice to you would be to start small for the Debt Crusher/Investment allocation percentage to get use to this. The goal is to never decrease your percentages on anything besides expenses. Every quarter, adjust your percentages closer to where you want to be.
Here is a picture of a make belief personal account for a visual:
Income xxxxxx1234…………$0 ($1000 check was disbursed accordingly)
Expenses 75 xxxxxx4321…………$750
Fun Money 15 xxxxxx2345…………$150
Debt Crusher 5 xxxxxx5678………..$50
Vault 5 xxxxxx7654……….$50 (After you reach your 3 months of expenses, you can stop allocating here)
There you have it, profit first methodology for your personal finances. I use this system in my personal and business accounts because it gives me instant knowledge about where I stand financially and allows me to make better decisions. If you want to dig deeper, I strongly recommend you read the book “Profit First” by Mike Michalowicz. I get nothing for promoting it, but I would love for it to positively benefit more people and businesses.
PS: If you are thinking about giving this a try and need some more guidance, I’d be happy to dive deeper with you. Just shoot an email to firstname.lastname@example.org with the subject line “Profit First.”