Franchising Your Business? Start With a Financial Model
♫ Tuesday, June 29th, 2010
Individuals looking to franchise their business should start the process by building a realistic financial model. This article provides a blueprint for franchising a business with an emphasis on the importance of using a realistic and conservative financial model.
Each day untold business owners consider the possibility of converting their business to a franchise. The benefits of franchising can be rewarding for business owners that seek growth and increased profitability. However, there is that all important caveat: The business must have the attributes to successfully operate as a franchise. There are important questions to consider when considering franchising. Here are a few of the more important ones:
· The market size for the product or service
· Quality of the company operation
· Ease of operating the business
· Ability to package or “cookie-cut” to a franchise operation
· Management acumen of the company
· Competitive climate
· Projected franchise investment
· Amount of owners capital available to invest in franchising the business
· The projected profitability and ROI for a franchise operation
The last item on this list is where your in-depth franchise analysis should begin. This is not to say that the previous questions aren’t important, because they are. Rather, the ability of a franchisee to be financially successful is the critical piece of the equation and the one so often missed by potential franchisors. It’s instinctive for the business owner to focus on product, sales and operations.The Financial Model
Step 1
The first step in the process is to construct a pro-forma financial statement for a franchise operation.You should construct the pro-forma based upon the financial results of one of your actual locations. Use a spreadsheet format so that you see various financial models. If you don’t know how to use a spreadsheet program find a family member or friend who can assist you. The advantage of using a spreadsheet is that you can change the entries to show various results. Known as sensitivity analysis multiple pro-forma’s allow you to depict different financial scenarios.Adjust the financials for the following:
1. Take out any unusual expenses that a franchisee would not have to incur.
2. Include salaries for employees who devote their efforts to the franchise operation and not for other business activities, such as the bookkeeper or the owner.
3. If there is more than one company location and collective expenses are recorded on one location you need to use an average of these
expenses for your pro-forma. An example would be advertising or supplies.
4. Make sure that the sales figure is realistic. It makes little sense to use a sales figure for a location that’s been open for several years since a franchisee must start from zero. Adjust to reflect sales for a first year operation. Don’t expect a franchisee to achieve the same level of sales that the current business is at.
5. Add owner income, amortization, depreciation, interest, owner perks and non-productive salaries to the pre-tax income.
6. Be sure that the gross margin per-cent is realistic. If you’re going to adjust err on the conservative side.
7. Calculate the pre-tax income.
8. Use 7% -10% of sales as an estimate of royalty and advertising fund fees. Deduct this amount from the pre-tax income.The result should be an estimated income for a franchise operation.
Step 2
Estimate the investment required to start up a new location. You’ll need to include the costs to open the business and market the products or sales. Include six months of working capital.
The pre-tax income from the franchise should range from a minimum of 30% to a high of 50% of the total investment. This would reflect an ROI of 15-20% and the additional income for the franchisee’s time and effort in running the new franchise location. If your pro-forma has these results you’ve passed a critical test in the process. On the other hand, if your results do not reach these benchmarks but are close consider how increased sales and/or lower expenses can be accomplished to increase earnings.
Building a financial model for a proposed franchise operation is a critical step in the process of franchising an existing business. If the financial
model is realistic and based upon reasonable expectations then you’re ready to proceed to a more detailed analysis of the market, operation
and competition.