Franchising your Business? Start with a Financial Model
by Ed Teixeira
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:
- Take out any unusual expenses that a
franchisee would not have to incur.
- 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.
- 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.
- 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.
- Add owner income, amortization,
depreciation, interest, owner perks and non-productive salaries to the pre-tax
income.
- Be sure that the gross margin per-cent is
realistic. If you’re going to adjust err on the conservative side.
- Calculate the pre-tax income.
- 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.
© 2010 FranchiseKnowHow, LLC
Ed Teixeira is the President of FranchiseKnowHow, LLC. He can be reached at
franchiseknowhow@gmail.com
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