Profitability ratios indicate to the franchisor how effectively the franchising business is being managed. These ratios provide the franchisor information about the company's bottom line -- simply stated they describe how successfully the firm is running the business.

Net Profit on Sales Ratio.  The net profit on sales ratio (also called the profit margin on sales ratio) measures the headquarters' organization's profit per dollar of sales. The profit margin on sales ratio is calculated as:

net profit on sales ratio = net profit / net sales

Franchisors tend to believe that a high profit margin on sales is necessary to maintain a successful business operation --this is often a myth. The franchisor should consider the organization's assets value, inventory levels, receivable turnover ratios, and total capitalization. For example, a typical convenience store may earn an average net profit of only two cents on each dollar of sales but the inventory may turn over as many as thirty times a year. The net profit on sales ratio varies from one industry to another. For example, a service company may have gross profit margin of 85% whereas a manufacturer may have only 35%.

Net Profit to Equity Ratio.  The profit to equity ratio (or return on net worth ratio) measures the franchisor's rate of return on investment. This is a very basic financial ratio that many investors look at before investing their money. This is one of the most important indicators of the franchisor's profitability or the franchisor's management efficiency. The net profit to equity ratio is computed:

net profit to equity = net profit / owners equity (or net worth)

This ratio illustrates the profits earned during the accounting period with the amount that the franchisor or owners have invested in the business during that time period. If this return is low, then the capital could be better employed elsewhere.

Business ratios are used as yardsticks in measuring the performance of their financial activities. Caution should be taken, though, in developing and reviewing financial statements. Several organizations provide information about financial performance of businesses across the wide range of industries. Some of the more common financial statements include:

Dunn and Bradstreet Inc. Dunn and Bradstreet offers "key business ratios" which covers twenty-two retail, thirty-two wholesale, and seventy-one industrial business categories. Dunn and Bradstreet also publishes cost of doing business which is compiled from IRS statistics of income.

Robert Morris Associates was established in 1914. They publish the Robert Morris Associates Annual Statement Studies which provide ratios and additional financial data for over 350 different industrial and wholesale categories. This report is probably the most used by financial consultants.

Bank of America publishes the Small Business Reporter which develops costs of doing business for several industries.

Trade associations.

Government agencies.