Most people choose a franchise based on what they dream of doing: running a restaurant, operating a landscaping service, managing a store, etc. Few are inspired by bookkeeping, preparing financial reports or managing cash flow. Yet these tasks are crucial to your business' financial health, and done poorly, they'll turn dreams into nightmares.
Basic business accounting
Proper accounting systems, records and analyses are vital to the success of your franchise. Not only do they help you secure financing for startup, they also allow you to monitor your franchise and minimize both business and personal taxes you have to pay. However, when investigating franchise opportunities, make sure you can accept the financial and accounting responsibilities with which you must comply—your franchisor will not assume a large share of your financial, accounting or reporting obligations.
Good software can perform many bookkeeping and accounting tasks, and you can always consult with an accountant to help you understand and act on the financial information generated. However, you should at least know how to read and assess a balance sheet, along with income and cash flow statements. These requirements begin well before you open for business, as the following steps illustrate.
Assessing the franchisor's financial health
Your franchise will struggle if the franchisor's own business isn't financially healthy. There are a number of ways you can determine this ahead of time. Start by requesting disclosure documents from the franchisor. Should you live in Ontario, Alberta or Prince Edward Island (or the franchise company you are investigating operates in these provinces), legislation requires the franchisor to provide you with disclosure documents prior to signing a franchise agreement.
Disclosure documents include proposed franchise agreements and financial statements, e.g. the balance sheet, statement of earnings, income statement, cash flow statement and a statement of owners' equity. The financial statements must be audited by a chartered accounting firm and will therefore include accountants' notes. These notes can provide insights into the statements, including any special concerns.
Ask an accountant experienced with franchises to help you review these statements to determine whether the franchisor has a history of profitable operations and whether the company seems financially stable today. Since a franchisor's cash flow includes future royalties and fees from new and growing franchisees, you need to know whether income from these sources is increasing every year. Are new franchise locations opening as scheduled?
Perhaps the most helpful information in the disclosure documents will be the list of current franchisees and their contact information. Use this opportunity to call several of them and ask about their experiences with the franchisor.
While these documents are the starting point, they should not be the only information you rely upon. You must feel sure the franchisor is reinvesting in areas that support the long-term success of its franchisees, such as improvements to the franchise system and franchisee support, as well as research and development (R&D). Both the franchisor and current franchisees can provide you with this information.
Assessing your earning potential
You'll need to know how much you can earn from your franchise, though the answer is rarely clear-cut. Disclosure documents may provide sales figures for various franchised locations within the system, but your potential location might not perform as well as others have. In any case, you'll also need to go beyond the disclosure documents to determine your potential revenue, profits and income.
Some disclosure documents include 'earnings claims' (financial information that enables prospective franchisees to predict potential costs, sales, income and profits) for various locations within the franchise system. In other cases, you'll have to rely on income and expense- or cash flow projections (separate documents representing a franchisor's estimates of the future financial performance of a franchise), using them to calculate a range of actual or potential sales, costs, income or profits from the franchise.
The disclosure documents should also indicate the market conditions upon which claims for earnings are based, as well as any factors that could significantly impact results, such as location, product mix or seasonal fluctuations. You can also ask an accountant with franchise clients in your sector how to interpret earnings, and whether they are feasible for your proposed franchise.
When speaking with current franchisees, ask if they are earning the amounts projected by the franchisor. If they aren't, find out why.
