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Profit, not turnover – how to evaluate the franchise opportunity [Guide]

Sarah Stowe

Below is a summary of our guide “Profit not Turnover”. Download the full guide.

It can be fun to dream about how much profit you’ll make in your first year in business, but have you thought about what profit is and whether your dream is realistic?

Some businesses do make a profit in their first year, but not all – even in a franchise system. Kate Groom, co-founder of SmartFranchise, says “The reality is it takes time for a business to consistently make enough revenue to cover all the expenses, pay a wage to the owner, and have something left over as profit.

So what is your idea of profit?

This may seem like a silly question, but profit can mean different things to different people – even to different accountants. So when it comes to assessing a business it’s important to be clear what you’re thinking of, says Groom.

“For instance, are you thinking profit is the money received from customers before or after paying business expenses? Is it before or after tax? Would you have paid yourself a wage? How do loan payments fit in to the picture?

“After all this, what reason do you have to think that profit number is realistic?”

So here are some things to bear in mind as you get an understanding of the financial side of the business.

Profit or turnover?

According to franchise accounting specialist Tanya Titman, director of Zee, when buying a franchise business most people focus on turnover. A franchise’s turnover can look impressive – “this business consistently makes $40,000 a month”. The figures presented to prospective franchisees are often the business turnover (or sales), not its profit.

For example, a business making $40,000 a month might have expenses of $35,000 a month, leaving a profit of only $5,000 a month.  When looking for a franchise to invest in, it pays to drill down into the figures to find the business’s profit (sales less expenses).  

What is profit?

Profit is the financial benefit when revenue from business activity exceeds the expenses needed to keep the business going. As a simple equation:

Profit = Total Revenue – Total Expenses

Says Groom, “This raises another question: “What’s included in total expenses?” People usually agree it includes all the business costs, for instance cost of goods, rent, electricity, royalties, accounting fees and staff wages.

“But what about your wages if you work in the business?” In a franchise, there can be debate about whether profit is before or after owner’s wages. Do you consider a business to be profitable if owner’s wages aren’t taken into account?

“You might want to think of profit as what’s left after paying yourself a reasonable wage,” suggests Groom. Which then raises the question, how long will it take to reach that point? The way to get a sense of this is by preparing a budget and cash flow projection.

Importance of profit

The desire to generate an income and build wealth underlies every decision to join a franchise network. Aspiring franchisees should expect their new business to make a profit. This will enable them to draw an income, pay back their initial investment plus fund other investments (such as purchasing a vehicle) as well as personal financial goals like additional superannuation contributions or a family holiday.  

Accountant Naomi Mitchell at YCG says “As a rule of thumb, I generally recommend your business plan show profitability after two to three years. If profitability within this timeframe appears unlikely then it’s possible that the eventual return on your investment will fall below what you may be able to find elsewhere.”

A business’s profitability is also crucial to an exit plan. If you decide to sell the franchise, its sale value will depend significantly on how much profit the business has achieved and what it can produce in the future.