We’re diving into an exciting topic today – how to effectively reduce debt while implementing the Profit First system. If you’re not yet familiar with Profit First, check out our previous YouTube videos for a comprehensive overview. Stick around to the end, because I’ll be sharing a fantastic spreadsheet resource with you.
One common concern we hear about Profit First is, “How can I allocate funds for profit when I’m burdened with debt?” It’s a valid question, especially if you have business debt like credit lines, business credit cards, or loans. Reducing debt is undoubtedly a priority, but that doesn’t mean you can’t reward yourself and set money aside for profit. Profit First has a strategy for debt reduction that might not be immediately apparent, but it’s incredibly effective. At the end of each quarter, you’ll examine your profit account, and here’s where the magic happens.
Let’s say you’ve accumulated $500 in your profit account. Normally, you’d take $250 as a profit distribution, maybe treating yourself to a spa day or a new gadget. However, if you have business debt, you can allocate 90% to 95% of that profit, say $240, towards your debt. Yes, it leaves you with only $10 for personal enjoyment, but it’s a reward nonetheless.
The Profit First Debt Reduction Strategy
Now, you’re taking that $240 and applying it to your debt every quarter, providing a substantial boost to your debt reduction efforts. Of course, during regular months, you’ll continue making minimum payments on your debts, but these quarterly injections create a snowball effect that drives you towards financial freedom.
The Snowball Method for Debt Reduction
To supercharge your debt reduction journey further, consider implementing the snowball method. This approach, popularized by financial guru Dave Ramsey and mentioned in the Profit First book, is particularly effective when you feel stuck and aren’t making significant headway in paying off your debts. The snowball method can also be applied to personal debt, not just business-related obligations.
Imagine you have a list of debts, ranging from smallest to largest: $300, $2,500, $4,000, $5,000, and $7,500. Alongside each debt, note down your minimum monthly payments: $25, $75, $150, $200, and $300, respectively. The key here is to focus on paying off the smallest debt first, regardless of interest rates. Why? It’s about winning the mental game. When you clear one debt, you’re not just reducing the total amount you owe; you’re also eliminating one of the debts entirely. This psychological boost can be incredibly motivating.
Snowballing Your Way to Debt Freedom
Continuing with our example, start by tackling that $300 debt with full force, even if it has the highest interest rate. By concentrating your efforts on one debt at a time, you begin to see progress. Once you’ve paid off the $300 debt, take the $25 you were putting towards it and add it to the next debt’s minimum payment. So, the $2,500 debt, with its $75 minimum payment, now gets an extra $25, making it $100 per month.
This is where the snowball effect comes into play. As you retire each debt, the money you were allocating to it gets funneled into the next one. In essence, you maintain the same total monthly payment, but you’re aggressively tackling individual debts one after the other. It’s a powerful way to build momentum and create a sense of accomplishment.
A Tool to Supercharge Your Debt Reduction
Now, I want to introduce you to an incredible tool that can revolutionize your debt reduction strategy – a spreadsheet from Vertex42.com. This user-friendly spreadsheet allows you to input all your debts, interest rates, minimum payments, and any additional payments you want to make. Then, it runs various scenarios to determine the most efficient way to pay off your debt.
Whether you prefer the snowball method or targeting the highest interest rate, this spreadsheet can provide insights into how long it will take to become debt-free and how much interest you’ll pay along the way. You can even prioritize specific debts based on your financial goals. It’s a game-changer for anyone serious about reducing their debt.
Debt reduction and the Profit First system can go hand in hand, allowing you to reward yourself while making progress towards financial freedom. The snowball method provides a psychological boost as you eliminate individual debts, and the spreadsheet tool empowers you to fine-tune your strategy.
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About Abby Johnson
Abby Johnson, is Matterhorn Business Development’s Chief Mentor, resident organizational genius and Certified Profit First Professional, helping our clients grow and organize their businesses. With a passion for empowering businesses to thrive and extensive experience in helping clients grow their revenue and manage their finances profitability, she’s committed to making a positive impact on your business.