Franchise accounting: The basics

Taking on a franchise is a big step for those who choose to do so. It has a number of immediate draws, such as being able to tap in to a tried and tested business model. However, there are additional risks that you generally wouldn't associate with a typical small business. If you choose to take on a franchise, it's imperative that you understand the potential pitfalls and, most importantly, how to maximise the opportunities of operating a franchise business.

The advantages

A franchise is based on a proven concept which typically offers products and services that have already been market tested. In most cases, the franchisor provides detailed manuals and guidance in respect of the following areas:-

• Set up, training and planning
• Overcoming initial issues and problems
• Operating the day-to-day business

If the franchise is well established there will be a plethora of data available for you draw upon. This will come from the past successes and failures  Some franchisees will have failed whilst others have succeeded, this will help to provide a list of the main KPI (Key Performance Indicators) that should be focused on in order for the franchise to be a success.

The risks of a franchise are significant

Franchises have a number of risks that you wouldn't typically encounter with a traditional small business:

Start up debt - Upfront franchise fees can add substantially to start-up costs.

High initial staffing – Traditional businesses typically begin as sole traders and increase staff levels as the business grows. Most franchises require high staff levels from the beginning.

Extra overheads – The franchisee will have to pay monthly franchise fees. This requires larger turnover to break even and it also means cash flow will require tight control.

Sales targets – A number of franchises succeed by delivering products and services at low cost. As margins are typically low, a decline in sales can have a massive effect on profit.

Controlling the risks

In order to control these risks, franchisees need measures and systems in place to control the following...

Controlling debt

Franchisees typically start with more up-front costs than a traditional small business. This can include:

• A sign up fee for joining the franchise network
• A refit of a prominent store location
• Wages that have to be paid while staff are trained

It is likely that funding this will initially require taking on debt. There are a whole range of finance options currently available. The key points to consider when taking on funding to finance a franchise include:-

• Having the flexibility to refinance should a better funding option emerge
• Regular reviews of debt to ensure that the lowest cost funding option is utilised
• Ensuring that cash flows are strong enough to service the debt payments

Tight control of cash flow

Cash flow in any small business is crucial; without a steady stream of income the business would be unable to continue. This is even more of a challenge in a franchise as there will be constant payroll and franchise fees being paid out of the bank account.

Robust monitoring of the cash position and detailed cash flow forecasting is of paramount importance to ensure sufficient cash is held to cover upcoming payments. The recurring payments such as loan repayments and franchise fees will be known. This will help to ascertain the cash flow that is required to cover these payments.

Identification of key performance indicators

Depending upon the industry, there will be several KPIs that are crucial for the franchise to be a success. By focusing on specific KPIs, your chances of success are significantly improved. These may include:

• The number of customers entering the store
• The quantities of a certain product sold
• The number of recurring customers

Monitoring key performance indicators

Once the specific KPIs have been selected it will be necessary to put in procedures to monitor and measure them. And it goes without saying that some KPIs will be more difficult to measure than others.

Once these procedures are in place it will be necessary to do the following:

• Set targets and S.M.A.R.T objectives
• Formulate a plan as to how these targets can be achieved
• Produce a schedule for reviewing the franchise's progress compared to this plan

Improving the probability of success

There are some relatively simple things you can do to increase your chances of success:

Professional advice – A franchisee often invests significant funds in order to acquire a franchise and there will also be significant operating costs involved in the daily running of the business. In order to protect your investment and improve your chances of business success, it is highly beneficial to obtain professional, industry specific advice from an accountant. This advice may cover:

• The treatment of franchise fees in terms of tax
• Managing costs and expenditure
• Compiling the information to be reported to the franchisor

Monitoring and reporting – In order to give the franchise the best chance of success, constant monitoring of cash flows and KPIs is required. An accountant will provide advice on the best solution to this.

Reporting systems for franchisees

Technology and software now means there's a host of  reporting and monitoring opportunities available to business owners. An excellent solution for franchisees would be a combination of Xero and Spotlight.

Xero – This is a cloud based accounting software package which has the ability to be linked directly to your business bank account. Bank updates and financial data flows directly into Xero. This means that accounting information can be reported in ‘real time’.

Spotlight – This is an app that can be ‘bolted on’ to Xero. It allows you to quickly prepare detailed financial forecasts and monitor KPIs, in addition to benchmarking against the performance of other franchises. This benchmarking will provide you with valuable insight into the overall performance of the franchise in comparison to industry standards.

How can Haines Watts support your franchise?

Haines Watts is a Xero Platinum Partner. Our team can help you examine your business and put in place measures to monitor performance, benchmark against key performance indicators and forecast different future scenarios. Get in touch with Chris Hird for more information or to discuss your current business challenges.