If you start a new business or have been running Profit First for a while, you may be faced with the problem of how calculating your allocation percentages. Should you be using real revenue or total revenue when calculating the allocation percentages?
Real Revenue - Revenue after all your materials & contractors are accounted for
Real Revenue is the revenue after all your materials and contractors are accounted for. This is the revenue that is left over to be allocated to your Profit First Bank Accounts (Profit, Owners Pay, Tax and Operating Expenses). It’s also called Free Cash Flow, or FCF.
For example:
Let's say that your business has $100,000 in sales and $10,000 in Materials and contractors to deliver your job or generate that income. Your Real Revenue is $90,000. This $90,000 is what you split between your Profit First Bank Accounts.
Total Revenue - before expenses and Materials are accounted for
Total revenue is the total amount of money that a company generates from the sale of its goods and services. It's calculated by adding together all of the individual products or services sold by a company during a particular period.
Total revenue can be expressed as a dollar amount or as a percentage of another measure, such as total income or total sales.
Total revenue is one component of overall profitability since it represents how much money was brought in from business operations during a given time period.
But it doesn't tell you anything about how well these sales were profitable — that is, how much profit was generated per $1 spent on bringing goods to market — or whether any expenses were incurred along the way that reduced profits further still.
What Should You Use
The Profit First method uses Real Revenue to calculate the allocation percentages.
Why you should use real revenue over total revenue?
Because it reflects how much money is actually in your business account at any given time.
Real revenue also provides a more accurate picture of how much money you have available to allocate towards each category/bucket for purposeful spending.
You should not use total revenue in calculating the allocation percentages. Total revenue includes all costs, both variable and fixed, whereas real revenue is only the gross profit from sales.
The most common example is Amazon.com, which reported $136 billion in total revenues in 2018 but $10 billion in real revenues.
Your allocations should be based on the actual real revenue of the business, not on gross sales or turnover.
Takeaway
Use real revenue as it will help you with cash flow issues. You will have a clear goal of what your expenses are now. You know how much money will be in your business, which is good for planning ahead.
If you're new to Profit First and looking for an easy way to understand this concept, think about how much money you'd like to make each month after paying yourself first out of every dollar you make.
If you need further assistance with calculating allocation percentages or the Profit First Method in general, please feel free to contact us.
We offer a free 1:1 Profit First Health Check appointment to be able to help individuals, business owners, and entrepreneurs like you in their Profit First Journey.
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