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The Pro-Forma Franchisee Income Statement: Be Aware of False Expectations

by Ed Teixeira

There is one aspect of franchising a business that must be carefully scrutinized.

Franchising an existing business requires careful evaluation, preparation and planning. In addition, it requires ample capital to complete the franchising process and launch the franchise program. An important component of the franchising process is having a qualified firm complete a feasibility study. A feasibility study will include whether the business can be successfully franchised, who the competitors are and to create the framework of a franchise model. Although each component of the feasibility study is important, there is one area that is especially critical. Namely, the construction of the pro forma franchise income statement.

Using the financial performance of the existing business as the model, the franchisee pro forma income statement should be modeled as closely as possible to what a franchisee would experience in terms of revenues, gross margin and expenses. Inserting the royalty rate and other fees in the model will enable one to establish a snap shot of the income statement. When done on a spreadsheet the entries can be changed to create various scenarios.

Where the Problem Lies:

Since constructing the pro forma will utilize the company's financials and then inserting the appropriate royalty rate and other fees, the result should be a reasonable projection of future franchisee performance. However, since the franchisee will have expenses and monthly fees that the business owner doesn't have herein lays the rub.

1. Given the added royalty expenses and fees added on to the financial model, a franchisee would have to do a better job operating the franchise than the original owner of the business if the goal is to match its profitability.

2. A new franchise may have more fees to pay in addition to the basic royalty. A franchisor may charge software, ad fees and other fees that will add to the monthly expenses.

When a new franchisee opens their business as part of a startup franchise system, there is little brand recognition and more than likely limited market share. Constructing a franchisee pro-forma income statement as part of a new franchise program requires the new franchisor to avoid false expectations. This means that the new franchise shouldn't be expected to perform as well as the business the new franchise is based on.

2015 FranchiseKnowHow, LLC

Ed Teixeira is the President of FranchiseKnowHow.com and Chief Operating Officer, FranchiseGrade.com. He is a former franchise executive and franchisee. He can be contacted at 631-246-5782 or at  franchiseknowhow@gmail.com



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