When you buy your franchise and start trading, you’ll need to have some funds to help you through the first weeks and months of business.

James Scurr spent nearly 10 years as a multi-unit franchisee for Boost Juice and Dreamy Donuts. He then took his experience to financial services businesses and four years ago founded Cashflow It to help deliver finance to business owners.

Scurr is well-placed to understand the financial demands on new franchisees and in this article he considers the key factors of working capital…

Working capital refers to a business’ ability to repay its current liabilities from its current assets and is simply derived by deducting those current liabilities from current assets.

A better way to express working capital is by using a ratio. If current assets exceed current liabilities, then the result will be a ratio of greater than one. Any ratio higher than one shows that the business can meet its short term obligations, the higher the ratio the better.

What is the most useful thing a franchise buyer can do to get the working capital right?

It’s going to vary from business to business.

For example, a franchise that needs to hold high levels of stock or work in progress is going to need higher levels of working capital to get through a normal trade cycle of turning that stock into revenue.

A hospitality franchise on the other hand could require lower levels of working capital since its stock, normally fresh food, is going to be turned over very quickly and revenue received typically on the same day it is sold.

If your business has debtors, then keeping payment terms tight will assist in maintaining appropriate levels of working capital.

Common franchisee financial mistakes

The most common mistake we see is franchisees looking to buy into a new or existing franchise business and not budgeting enough or not budgeting at all for working capital in the critical early stages of the business.

Franchisees may have committed everything they can to buy the business and simply rely on quick sales growth in the early stages to fund the working capital the business should have.

Underestimating the amount of working capital needed is one of the most common reasons that a franchise business fails. Figuring out exactly what the number should be can be difficult, but there are lots of sources that can provide guidance.

New businesses can look to industry benchmarks as a basis for projections, as well as talking to existing franchisees who have more insight into the running of the business.

The reality of the first year can be very different to what is laid out in projections.