How To Calculate the ROI On A Franchise Investment

by Ed Teixeira

If you’re considering purchasing a franchise, there are four  important financial questions to consider:

• How much is the investment in the franchise?
• What is your break-even sales point
• What is your projected pre-tax income?
• What is the return on your investment or ROI?

The key answer you’re looking for is what is your expected ROI? This represents what you can expect to earn on your investment. If your ROI is below a certain level you’d be better off investing your capital in a mutual fund or real estate.

To answer this question we’ve provided a simple ROI calculator that you can use to determine the expected or projected ROI. However, you’ll need to have some data to enter into the Franchisee ROI Calculator. This information is not difficult to gather and it should be part of your franchise due diligence process.

The Franchise Investment

The Franchise Disclosure Document (“FDD”) contains an Initial Investment Schedule known as Item 7. It includes an estimated low and high amount for a number of categories. Be careful not to use this as an expense schedule since it is an estimate of how much the franchise investment is. It includes a category “Additional Funds” which represents 3 months estimated working capital for personal and unanticipated expenses. In some cases this amount may be less than what’s needed until the franchise is at break-even.

Projected Pre-Tax Income

The next step in the process is to estimate your sales, gross margin and expenses. If you have this information you can enter it directly in the Franchisee ROI Calculator. This information should be available from the franchisor and existing franchisees. Items such as royalty, advertising fees , software fees, etc. are in Item 6. Rent, insurance costs and equipment are in Item 7 and can be used for reference. Franchisee salaries, telephone, advertising, etc. should be readily available. If you as franchisee intend to draw a minimum salary include that in the salaries category.

Some franchises will have a positive ROI after the first year while others may take longer. You can enter sales and expense data for one year or more. The calculator allows you to easily change entries.

 1. Project total sales for your first year of operation or longer. Be realistic and avoid being overly optimistic.

2. Establish a gross margin per-cent. If you’re going to adjust err on the conservative side.

3. Project your expenses for your first year of operation or longer.

4. Enter all of the data in the Franchisee ROI Calculator and it will determine the pre-tax income and ROI.

You can enter various amounts for each category including sales and gross margin to show different results. You can add extra working capital to the Franchisee Investment if you want to be conservative.

ROI Results

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 the results are not there but are close consider how increased sales and/or lower expenses can be accomplished to increase earnings.

Understanding what the estimated ROI is for a proposed franchise is a critical step in the process of purchasing a franchise. If the estimated ROI is realistic and based upon reasonable expectations then you’re ready to proceed to the next step in the process.

Click here to use our online franchise ROI calculator.

© 2010 FranchiseKnowHow, LLC

Ed Teixeira is the President of FranchiseKnowHow, LLC. He can be reached at franchiseknowhow@gmail.com