A common question asked by prospective franchisees that are reviewing a franchise opportunity is, “How much money can I make?” In response, the franchise salesperson avoids the question and assures you that you will have an opportunity to review the disclosure document and speak with franchisees. When you subsequently get the disclosure document you go to the earnings section and are faced with a statement that reads similar to the following: “The Franchisor does not give or authorize its agents to make any oral or written representations or estimates concerning the actual or potential sales, costs, income or profit of a franchise.” You then call the franchisees. Although they are willing to answer most questions, they become uncomfortable when you directly ask, “How much money are you making?”
How can you be expected to make a business decision and invest in the business when you are not provided with potential returns? This issue comes further to the forefront when you go to the bank and they ask you for a business plan with projections as part of approving your loan. They are looking for the evidence of the business being able to pay off the loan. Without this they are reluctant to lend you money.
Franchisors can make earning claims provided they can be verified and substantiated. Many franchisors today provide average gross sales figures of their franchisees and some may have clear earning claims in their disclosure, but several do not. Most franchisors find that the variance in earnings is so great that making any kind of a claim creates undue liability. Some franchisees are more creative than others in posting expenses, making it difficult for the franchisor to compare statements. With new franchisors, there is simply not enough of a track record to go on. Other factors influencing earnings include the franchisee’s management ability, operating efficiencies, competition, the economy and other local factors. As a result, it is almost impossible for franchisors to provide a reliable earnings claim. All of this makes it difficult for you to make a fully informed business decision.
The good news is that this forces you to do your homework. Take the time to develop your own spreadsheets. Put together a 36-month spreadsheet that captures all the income and expenses related to the business. Then start to fill in the blanks. You will end up being more informed and making a better decision than if you just blindly believed whatever the disclosure or franchisor representative tells you. The cash flow projections that you put together will become an invaluable management tool once the business is opened, allowing you to quickly see when you are on track and providing benchmarks that require seeking answers and making changes so that your profitability is achieved. Finally, you will have a better sense of your working capital needs during the startup phase of the business.
Expenses will vary from market to market. Find out what the labor salaries being paid in your community are. What are the rents? Your local chamber of commerce or economic development department may be able to assist. An accountant can also provide valuable insight. Speak with franchisees and ask them for their input. Show them your list of expenses and see if they see any expenses that you may have forgotten. What are their monthly expenses? Were there any expenses that were a surprise to them after they opened? What expense have they found to be the most difficult to manage?
Then there is the issue of sales. Asking a franchisee,” How much money do you make?” will often not provide you with the information you are looking for.
Alternative questions that you can ask that will often generate the answers needed are as follows:
• What is your monthly inventory turnover? (retail)
• What is your markup or margin?
• What is your average check and customer count per day? (restaurant)
• What are your billable hours, and what is your average hourly rate? (service)
• What is the seasonality of the business?
• How slow does it get during the off-season?
• How do you adjust your expenses during the slow months?
• How long did it take to get your business to break-even and then profitability?
After you have prepared the cash flow projections, forward them to a few of the franchisees to get their input. Forward a copy to the franchisor. The franchisor will be careful not to state if they are right or wrong but can review and see if there are any errors or major expenses that are missing. They have a desire to ensure that you are coming into the franchise with realistic expectations.
Put together two cash flow projections- a best case scenario and a worst-case scenario. Plan for the best but be prepared for the worst. This will allow you to sleep at night.
No matter how detailed your projections, there will be no guarantees. The economy could change. New technology could deem the business obsolete. A new competitor could come into the market. Review your projections regularly and be prepared to make changes as circumstances change.
Wayne Maillet is a franchise management consultant and founder of the consulting company Franchise Specialists. Respected within franchise circles, he brings a realistic, practical understanding of business and franchising. This article is based on excerpts from his book, Franchising Demystified. The book can be ordered through most book retailers or directly from the publisher at www.franchisingdemystified.com.