Match the passion for a franchise opportunity with sound financial planning and commercial reality, then reap the rewards, suggests Bill Locket of Franchise Systems.
Some interesting facts surfaced about business planning during a panel session at the October 2010 National Franchising Conference. The session focused on the importance of franchisees preparing annual business plans in a way that is interesting, simple and relevant so that franchisees would voluntarily become involved, provide them to the franchisor and annually update them.
It was apparent that forward planning was still seen as a chore and secondary to creating and sustaining a profitable business. It transpired most new franchisees had been coerced into preparing a business plan at the behest of the prospective franchisor to satisfy their entrance requirements and that these plans were based on estimates and projections provided by the franchisor (information provided of course with suitable and comprehensive disclaimers).
Franchisors are still wary of providing too much information to franchisees because of the fear of later legal action. Yet franchisees need to understand how the commercial side of the franchise works, so that they can make a sensible decision as to whether to invest.
As franchise advisors we are asked by many prospective franchisees to advise them on the business opportunity they are looking at. In most cases where a greenfield or start-up franchise is involved, a minimal amount of financial information is provided. Typically this is limited to the prospective franchisee’s initial investment and what the ongoing fee structures are.
These prospective franchisees are often excited about the business concept but have no real idea about the commercial aspects, such as the operating expenses and, most importantly, how much profit and return on investment they can achieve.
Franchisees should ask the franchisor to provide a template or franchise modelling tool which can be used by prospective franchisees. Ideally this would be an interactive model that allows them to input their own thoughts about the performance of the business, and look at different scenarios.
In an ideal world the prospect would work through the model in conjunction with their financial adviser. But even if they prepared it themself and presented it to their adviser at a later date, the adviser would have something concrete to work with, rather than the often limited information that appears in the disclosure document.
The inputs should focus on the basic drivers of the business and be tailored to the specific business to create a model based on such key items as estimated sales, cost of goods, staff rosters and costs, operating expenses such as rent etc. Once the assumptions are inserted, the model should produce a detailed monthly plan for the first term of the franchise. The figures produced can then be inputted into their financial software which then gives a budget comparison figure when they produce their future monthly and yearly operating results.
In order to assist the prospective franchisee and their adviser with the inputs, information should be provided from the existing operations of other franchisees or franchisor operated outlets.
The key benefit to the prospective franchisee in completing such a model is that they will have much clearer picture of the potential of the opportunity in financial terms, rather than having just a warm and fuzzy feeling about the concept.
The model can include the means of calculating the costs of borrowings, the amount necessary for owner drawings, the development of employee rosters or activity plan, the importance of controlling debtor days, the need and amounts of extra working capital to cover debtors, the alternative costs of vehicle purchase or leasing, the ramp-up of business in the first year of operation, seasonal variations by month, the expected increase in sales and prices over the next five years and the expected annual increase in expenses.
Investment
Many people forget that in starting a new business, it will take time to grow to what would be considered a ÔnormalÕ level of sales. During that time the franchisee will need to incur many expenses that will not be covered by cash flow and they will need to make an allowance. An effective modelling tool will calculate this figure.
Sales projections
In a retail franchise, sales will generally be created as soon as the business opens, especially if it is an established location. However in new locations or for service franchises it will take time to grow so the model should cater for that ramp-up, as well as any seasonal variations. How the business will grow year on year will also need to be added to the equation.
Cost of goods
This aspect can make or break a business. The franchisor should be able to advise what the current situation is, especially as it relates to different categories of merchandise.
Roster and hours
In a retail context, wages are often the major expense, so the franchisee will need the model to create a roster from the bottom up, by hour, by week, by type of employee, by age, as well as assessing the needs of the business when sales exceed the norm.
Expenses
The ideal model will allow the franchisee to input their expected expenses. In some cases it will involve a simple monthly budget, but some expenses are dependent on the level of sales, so the facility to input either would be beneficial. Allowance should also be made for the increases in expenses that will occur in future years.
Profitability
A summary of the profitability of the business for the first five years will give the prospective franchisee an opportunity to see whether it will be sufficient for them to pay their personal bills and have some money left over.
Return on investment
The franchisee should also consider the return on investment. In the life of the first term of the franchise they should expect to be able to pay off any borrowings, earn a reasonable income for themselves, and make a reasonable return on investment. In addition, they will have generated a value in their business which can be sold, if they wish.