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Collecting and Analyzing Franchisee Financial Statements

Franchising World, April 2007

“I can’t guarantee what you will make, but I can tell you what the average franchisee is making.”  

Collecting financials in the franchising sector is by no means a common practice.  In fact, it’s rarely done at all and is rarely correctly done.  Smaller franchise companies believe they have a good handle on things, because of their personal interaction with their limited franchisee base. More established franchise companies might consider it such a monumental task that they don’t see how it could be accomplished. There are many reasons why franchise systems don’t collect financials, including:

•   The franchise system gets franchisees’ sales and that provides all that is needed.  A franchisor who was doing about one million dollars a year in sales when the firm first started was netting about $150,000.  By the fifth year, sales had grown to a little more than three million dollars and the net dropped to a loss of $380,000.  Did the sales tell the whole story?

•   Companies are on a fixed royalty so it doesn’t matter.  Don’t they have to keep their doors open to keep getting the fixed fees?   The collection of financials is not to justify royalty fees, but rather to help determine best business practices to grow the entire franchise network. 

•   The franchise system has tried, but the franchisees just won’t send them in.  How much of a priority is it?  It has to be conveyed that it’s for the good of the entire franchisee network to collect financials from each franchisee.

•   The franchise system collected them in the past, but it was too much work to compile.  It’s understandable that a system doesn’t want to re-key 400 profit and loss statements into an Excel file. The financials have to be useable, if they are not, why even collect them? 

Financial statements for any business serve as a scorecard because this is:
•   How the business owner should be measuring the results of his business. 
•   What the investment world looks at to determine a business’s worth.
•   What the banks use to determine the business’s viability (and ability to repay). 
•   What any potential buyer of a business should want to see.
•   The best way for a franchise system to determine that it is doing its job in supporting its franchisee network. 

It all starts with franchisees having good, clean books
All franchisees should have financials and know how to read them.  Unfortunately, not all franchisees have a solid business background or may not understand how to read the financials.  Most small-business owners use their financials for three things:

1) Get their tax return done at the end of the year,
2) Get a loan from a bank or investor, and
3) See if they lost or made money.

Franchisee financials should be reviewed at least monthly because it’s vital that the franchise company and franchisees know their strengths and weaknesses.  Running a business without reviewing its financials is similar to trying to judge whether or not a person can walk or run a mile faster each day without ever being timed. 

Below is a brief description of the financials each franchisee should review monthly and what can be learned from them.  These are the same financials the franchise system should be collecting as well.  This may seem elementary for some, but it’s always good to get back to the basics. 

The Balance Sheet
What can be learned from the balance sheet: 

•   Is the business cash strong or weak? Does it have any?  If so, how long can it survive on its holdings? 
•   Are the income-producing assets tangible or intangible?
•   Is the business under-capitalized?
•   Is the business burdened with too much short-term debt?
•   Is the owner draining the business of its working capital?

The Income Statement
A properly prepared income statement can tell the reader a lot about a business:

•   Is there enough gross profit to pay the bills?  Is the business losing money?
•   Is the business owner killing the business?  Is the owner taking excessive wages, too many perks or fringes, or just plain mismanaging?
•   Is the business owner investing in expanding the business?  Any marketing expenses, 5 percent of gross, would probably indicate that a valid attempt is being made.
•   How is the business planning for the future?  Gather income statements for each month for the last few years and determine trends, identify the    good and bad months or quarters.  Once these trending patterns are recognized, one can develop a plan for the future and decide how to accentuate the positives and eliminate the negatives.

Combination of Balance Sheet and an Income Statement 
For this section, assume that there is a year-end balance sheet and income statement, which covers the year ending on the date of the balance sheet.Here is what can be learned: 

•   How long can the business survive without sales on just its cash reserves?
•   How many days, on average, does it take to collect accounts receivable? 
•   How many times does inventory turn over? 

Statement of Cash Flow
The purpose of the statement of cash flow is to explain to the reader of the financial statements the change in cash balances for a given period of time.

The statement of cash flow starts with net income and then will add back any non-cash deductions such as depreciation or amortization.  Next it will take the reader through changes in the balance sheet to show the amount of cash the business produced or lost from operations, how much cash was produced or used from investment activities and finally, how much cash was produced or lost from financing activities.

It is important that franchisees know their numbers.  A mentor used the following statement:  “What you measure, you manage, what you manage you improve.”

If the franchisee is not preparing and reading the financials, then he isn’t measuring, and how can he possibly manage and improve on something that isn’t being measured?

If a franchise system is not collecting franchisee financials and using the information to help the entire network, how can it adequately support the network?  How does the franchise company know if the advice it is giving is effective?

Here is the “bottom line.” When the individual franchisee knows where he stands financially, it will help him with his own personal success.  When the franchise system knows where franchisees are positioned financially, it will help with the success of the entire network.

Side-by-Side Financial Statements:  How to Run a Successful Collection Program
Depending on the wording in the franchise agreement, the franchise system may or may not have the right to access or collect financials from franchisees.  Even if it does have the right, chances are it won’t have the technology clauses in its franchise agreement to add such a program.  Considering this type of program will come with a small monthly cost to the franchisees (or the franchise company if it chooses to absorb it), it will have to be added to the franchise agreement for all new franchisees.  It’s then the franchise system’s job to convince current franchisees that participation in the program is in their best interest.  The reasons are endless, but it boils down to one: by having the financials from each location, the franchise company will be able to provide franchisees the type of advanced support for which they bought into a franchise company in the first place. 

Use a standardized chart of accounts
Before comparing one franchisee’s books to another, they have to be prepared in a consistent manner.  It starts with a standardized chart of accounts.  If left up to the franchisees and their accountant, the franchise system is going to get different variations all across the board.  One person may breakout all his utilities, phone and electric expenses, while another may lump them together.  It’s extremely important that the revenue accounts be named the same as well.  Without this standardization, it is almost impossible to compare and contrast the financials.  It also affects the ability to pull the side-by-side reporting.  

Standardize the Accounting Software Platform
Considering that QuickBooks holds a majority of the small business market, it’s a great place to start because most franchisees will already be using it.  QuickBooks is also a great application for this type of program given the amount of third-party programs it integrates with such point-of-sales systems.  Here are a few other things to consider: 

•   Be sure to use the same version of QuickBooks, Pro, Premier or Enterprise.
•   Keep them updated to the current version.
•   Try to integrate POS into QuickBooks to save franchisees or their accountants from manually entering the sales data.

Hosting of the QuickBooks File
The results received when franchisees are asked for the financials results in possibly 5 percent or 10 percent participation, which makes this next step vital in a collections program.  By using “hosted” technology, the franchisee has no involvement in the collection of the financials.  Here is how it works:  The franchise system is going to have all the franchisees’ QuickBooks files hosted in a central location.  What does it mean to have the files hosted?  The franchisees will no longer have their files stored locally on their own machine, but at an offsite server farm, where they can be accessed via the Internet.  Once all the files are located on this server farm, the franchise company will have the ability to go out and pull the financials right from their QuickBooks files.  Here are some important tips in selecting a suitable host:

•   Make sure the files are in a secure environment.
•   Pick a facility with disaster recovery built-in, such as a telecommunication data center.
•   Make sure the hosting company can support reporting requirements and is willing to host other applications that may be needed to complete this program. 

Now that a standardized chart of accounts exists, all franchisees running the same software, the files are hosted in a central server farm and financials can be compiled into side-by-side reports for the franchise system to use in a multitude of ways. 

Unlocking the Secret in the Numbers
At this point the franchise company has side-by-side financials from all locations.  With the methods used above it’s easier to assemble these reports.  This type of program can be utilized by franchise companies ranging from one to thousands of locations. 

The financials can now be used to determine best practices all across the network.  This is one of the best parts of franchising, the sharing of information.  When best business practices are implemented, franchisees are in business “for themselves, but not by themselves.”  Below is an example of some of the key indicators or ratios that one can look for when comparing franchisees’ financials:

•   Ranking based on net income, not sales,|
•   Who is getting the greatest return on marketing dollars,
•   Who has the best sales to employee ratio,
•   Who is carrying the least amount of debt,
•   Who is growing the fastest (net income), and
•   Who has the best cash flow?

Once the franchise system has determined the best franchisee in each area of operation, learn what they are doing and teach the others.  It’s that simple.  The process allows the franchise system to take a proactive approach in assisting others who may be struggling, rather than fielding calls from franchisees explaining that they have to shut their doors. 

When a franchise system has a profit and loss statement from each of its franchisees, the system will be able to do what every other franchise company cannot do: make an earnings claim.  This is one of the best ways to bring in new franchisees, allowing the franchise to say, “I can’t guarantee what you will make, but I can tell you what the average franchisee is making”.  

Ross Devereaux is CEO of My Back Office.  He can be reached at  ross@mybackoffice.org.