Franchise Basics

Franchise Accounting 101

Determine your ability to invest

There are significant financial obligations to investing in any franchise, so your personal financial health is crucial to its success. Don't rely on the franchisor's advice alone to decide whether you have the financial backing to buy and operate a franchise. While the initial franchise investment (including the franchise fee) for many companies seems attractive, there are often additional startup and operating expenses involved.

Startup costs can include much more than a franchise fee. An initial cash investment, legal and accounting fees, insurance, training, licenses, promotional fees, leasehold improvements, inventory, equipment, furnishings, fixtures, signs, landscaping and moving expenses might also require your cash.

There may also be numerous ongoing expenses. They include royalties, advertising fees (local ones, as well as contributions to regional or national programs), equipment maintenance, employee training, insurance, rent, inventory and more.

New franchisees typically lack cash for startup and operation. Therefore, your franchise will likely take time to start generating a profit. To prepare for this, ensure you have sufficient assets available to cover your personal expenses, as well as startup and ongoing expenses, during the early period. To be on the safe side, estimate what you need to operate the franchise for one year, along with your personal living expenses for up to two. An accountant can help you ensure your estimates are practical. You should also ask other franchisees how real life compares with your estimates.

Know your accounting responsibilities

Each franchise system has certain requirements related to ongoing accounting and financial management. Some franchisors, especially large, well-established ones, require franchisees to submit weekly sales reports and monthly bank statements. Some may pay GST, PST and payroll source deductions on behalf of their franchisees. Others may prepare monthly financial statements. Some will provide comparisons of budgeted to actual results to help franchisees achieve target profits.

Many franchisees appreciate having these tasks handled by the franchisor. However, there will be a fee charged for doing so. To determine which tasks are yours, and what fees the franchisor charges, review the provisions related to books, records and reporting in the proposed franchise agreement, found in the disclosure documents.

Monitor your franchise finances

The financial success of your franchise requires your full attention. Review the balance sheet, income statement and cash flow statement every month to assess net worth, net profits or losses and cash flow. On a quarterly basis, calculate the following financial ratios to evaluate key performance measures:

  • Sales year to date;
  • Gross profit margin;
  • Cost of sales as a percentage of sales; and
  • Labour rate as a percentage of sales.

By comparing these ratios to those of franchise or industry averages (often provided by franchisors), you can evaluate the progress of your enterprise. If you need advice or assistance, consult with an accountant experienced with franchises. This professional can help you interpret financial results and benchmark your progress relative to both competitive businesses and other locations within your franchise system. He or she can also guide you on how to strengthen results.

The bottom line

When deciding on a franchise in which to invest, select a financially stable company that provides the accounting support you need—and be prepared to share responsibility for the financial success of your new venture. As an entrepreneur, it's the least you can do!

Rick Chittley-Young, CGA, is a principal of BDO Dunwoody. He can be contacted via e-mail at rchittley@bdo.ca.