Hate maths? Love holidays? Read on
As the Christmas decorations went up, so did my dread. I’d tried to be good about setting aside tax for the January HMRC deadline. But, once again, I was raiding my personal savings to make up the difference. Why couldn’t I be more organised. Why?
Hello. My name’s Helen and I was a business finance phobic. After five years as a freelancer, finance continued to be my Achilles heel. It brought back all the bewilderment of Maths class at school.
But there is a better way. I now recommend using Profit First for UK freelancers. It’s a free and simple financial strategy which has transformed how I run my business.
What sort of UK freelancer or business suits Profit First?
Ever feel like you’re working incredibly hard but have nothing to show for it? Do you scramble around when it comes to paying the tax bills? Only have a vague grasp of how much it costs to run your business? Then this is the financial system for you.
The Profit First principle in a nutshell
When your invoice is paid, instead of keeping it in one account, you divide it up into different areas. And you pay yourself a profit first, hence the name.
The logically-minded may scoff, but the system is based on behavioural science and, more specifically, Parkinson’s Law which states:
“Work expands so as to fill the time available for its completion.” – C. Northcote Parkinson
It’s why if our deadline is in ten days’ time, we’ll take ten days to do it. It also applies to our relationship to scarcity. Profit First creator Mike Michalowicz talks about how careless we are with a full tube of toothpaste compared to how we squeeze out every last drop by the end.
When we see a zero balance in our business account, it makes us more frugal about running our business. The truth is we don’t have zero. We’ve squirreled away money for our bills and wages. But if it’s not obvious, our brain acts like we don’t have as much.
I’d recommend buying or borrowing the book Profit First by Mike Michalowicz. It’s a pacey, honest and sometimes funny read, plus a great reference source.
The Profit First bank accounts you (theoretically) need
Mike recommends setting up five separate bank accounts, plus two optional ones:
- Income – the business bank account where the money comes in
- Profit – to treat yourself for all your hard work
- Owner’s Compensation – as in your wage
- Tax
- Operating Expenses – such as printer ink, insurance and subscriptions
- Tax Vault (optional)
- Profit Vault (optional)
In the end, I set up just two new bank accounts, plus a savings account for 6. Tax Vault. Here’s the why and how.
Profit First and UK bank accounts – my workaround
In America, it may be that you don’t incur bank charges for accounts. But it’s not so simple in the UK, especially for business banking.
However, as my new online bank offered separate saving ‘pots’, I stumbled across an easy workaround.
Dealing with 1 to 4
The 1. Income account = the Business Account, into which your invoices are paid. Within it, I set up ‘pots’ for 2. Profit, 3. Owner’s Compensation, and 4. Tax.
But a 5. Operating Expenses savings pot wouldn’t be able to pay by Direct Debit or online expenses. I needed another current account.
Solving 5. Operating Expenses
When you request a business account with an online bank like Monzo or Starling, they may ask you to open a personal current account first. I was more than happy with my existing personal current account – codename Fort Knox for the sake of this article. Why did I need another account?
Then – light bulb moment! This new personal current account – let’s call it Newbie Dosh – could be my business’s actual Operating Expenses account.
A word about optional Tax Vaults and Profit Vaults
6. Tax Vault: It’s surprising how quickly tax racks up. Mike advises stashing it away every so often in a Tax Vault savings account. But in one which is awkward to access. Perhaps postal only or which penalises you for each withdrawal? That way you won’t be tempted to spend what is the government’s money, not yours.
I keep mine in Premium Bonds, which needs around 10 days’ notice for withdrawals. Prizes are tax-free too. Handy to know if you win big!
7. Profit Vault: You can do this with Profit too if you’re saving for something significant.
How Profit First works in practice
My client pays their £1000 invoice into 1.Income – as in my Business Account.
I hive off the following to ‘pots’ within Business Account:
- 5% of the £1000 goes to my 2. Profit pot – so £50
- 60% to 3. Owner’s Compensation pot – so £600
- 25% to my 4. Tax/National Insurance pot – so £250
- 10% to my 5. Opex – as in Operating Expenses – pot – so £100
This means I’ve cleared the ‘plate’ of the main business account and the balance is £0. But that’s OK, as I have money to cover my business expenses and tax.
Every fortnight or so I then transfer whatever is in the Opex pot to my Newbie Dosh account.
Here’s a diagram with figures:
Why these percentages work for me
5% Profit
This is admittedly high for Profit First. Mike recommends starting with 1%. I could have done this, and then taken 64% for Owner’s Compensation.
But because Profit is stored within my business account, it doesn’t feel right to raid it like I would a personal savings pot. Plus it’s lovely to have Ink Gardener Copywriting sending me on holiday as a ‘bonus’.
60% Owner’s Compensation
Better known as wages. It’s just easier to follow Profit First if you stick with Mike’s labels.
If I change any of the other percentages, this is the area that takes the hammering / gets the bonus.
Tip: I used to ransack the entire pot in one go. But now I transfer a weekly wage into my Fort Knox account. This makes personal finance budgeting easier. Also if there’s a work lull, there’s the reassurance I have X number of weeks covered.
25% Tax/NI
I’m a UK basic rate tax payer so assumed this should be 20%. But you MUST account for National Insurance Class 4 contributions. At the time of writing, these are a whopping 9% of any profits over £9,500 ish. Check out Self-employed National Insurance by gov.uk for the current rate.
Your Personal Allowance means tax/NI not exactly 20% tax for everything. And Payments on Account make it tricky to work out how much you will actually owe HMRC from one year to the next.
What are Payments on Account? Once your profits exceed £1,000, HMRC will ask for advance payments of half your previous year’s tax bill in January and July .
Hollies Bookkeeping suggests 30% to set aside for tax and National Insurance. But so far 25% has covered everything.
I put aside money from every transaction, starting from 1 April onwards. Because of the Personal Tax Allowance, this usually means at the end of the year, I get a ‘bonus’ as I’ve put too much away. Another reason to submit my tax return as soon as possible!
10% Operating Expenses
This has been a real Goldilocks figure. 15% was too much. 7% too little. For me 10% is just about right. I’m a freelance copywriter, so I don’t have to buy stock. However I do pay for business insurance, subscriptions, website hosting, software and printer ink. And Pilot pens. Lots of Pilot pens!
As the Newbie Dosh account is a personal current account rather than a savings account, it can deal with Standing Orders and Direct Debits. I make sure its balance is always in the black, with enough to cover the two largest monthly pay-outs at any one time.
Within it, I’ve set up other dedicated ‘pots’. Copywriting business coach extraordinaire Kate Toon introduced me to Profit First. And now there’s literally a pot with her name on, for my membership of her Clever Copywriting School. I also have an ‘Accountant fees’ pot. It’s a good way to save up throughout the year for significant, one-off costs.
Operating Expenses refunds any expenses made by my personal Fort Knox account. For example when I pick up printer paper at the supermarket during a grocery shop.
Profit First and UK freelancers – which bank account should you use?
These banks offer business accounts where you can stash money in different areas:
- Lloyds Bank
- Monzo – known as pots
- Revolut – known as accounts within the current account
- Starling Bank
Have I missed yours off the list? Please email me at helen [at] inkgardener.co.uk or tweet me at @inkgardener and I’ll add it on.
Frequently asked questions
Here are a few questions that have come up when I’ve explained Profit First for UK freelancers in the past.
I’m not sure. It still sounds complicated. Is it difficult to do?
Not at all! Honestly, percentages are a doddle to work out. And the peace of mind it gives you is priceless. Use the online percentage calculator website if you’re really struggling with the Maths.
Can I change these percentages?
Absolutely. It’s up to you. Every business and business owner is different. The Profit First book gives more suggestions.
A real benefit of Profit First is that it acts as an early warning system for business viability. You can’t cheat the percentages. If adjustments still see you in the red, you need to cut your expenses, earn more or pay yourself less.
Can I use set amounts rather than percentages?
You can, but then it’s not Profit First. It’s the percentages which are the game-changer. In a ‘feast’ month, you put more in. So when a ‘famine’ month comes along, you’re covered.
Can I move money between the pots?
Yes, although I only do it if there’s a significant surplus in Operating Expenses. Just don’t touch your Tax pot!
Does ‘1. Income’ deal with turnover or profit?
Turnover. Don’t know the difference? Check out my How to become a freelance copywriter article with lots tips for freelancers and start-ups.
I just can’t see the logic in the system.
Ah, the classic “Not so much a question, more of a statement.”
Fair enough. Profit First can be a bit Marmite and isn’t for everyone. If traditional book-keeping works for you, then by all means continue.
How did your accountant react?
To quote his email: “I am impressed!”
I only had to send him Excel spreadsheet versions of my 1. Income business account and my expenses (Newbie Dosh). It was such a relief to get the accounts to him early. It meant my July Payments on Account demand was accurate and I knew exactly what to pay HMRC the following January.
However there are Profit First accountants and book-keepers you can switch to if yours isn’t keen on it.
Want to find out more about Profit First for UK freelancers?
Here are some other UK businesses that are raving about it:
- How I use The Profit First System to run my business – Hazel Whicher. This also includes her Payments on Account shock and how she solved it.
- Best Bank for Profit First – Annette & Co.
- A Profit First Success Story – Raffingers Accountants
Let me – and Mike – know how you get on
I wrote this article to share the awesomeness of Profit First for UK freelancers. If you’ve any questions, please tag me @inkgardener and Mike – @MikeMichalowicz – into a tweet. I’m in no way affiliated to him, I just think it’s a cracking solution!
About the author
Helen Reynolds is a freelance copywriter with more than 25 years’ experience of writing for digital platforms. Helen presented her Maths teacher with her ‘My Horriblest Subject Is Maths’ poem on the final day of term. She now uses her ‘Favouritest’ subject of English to sow from scratch or refresh websites with customer and Google-friendly web content.
Based in York, Helen helps businesses across the UK and the world, specialising in heritage, hospitality, horticulture and health and wellbeing. Find out more about her freelance copywriter services.