Franchisor Book > The Franchisor Feasibility Plan > Financing and Accounting 

FINANCING AND ACCOUNTING

The priests of Ur in Mesopotamia created record keeping systems around 3200 B.C. to keep track of the transactions between the priests and the public.  Today these record keeping systems are referred to as accounting systems and have developed into major financial systems which allow us to understand the use and flow of cash in a business operation.  It is essential to the proper start-up and conducting of a franchise business to determine the financial projections necessary for the franchisor to begin operations, as well as to estimate the finances required for a franchisee to start a business.  Therefore, the franchisor needs to develop and keep two sets of financial records: (1) franchisor financial records, and (2) franchisee financial start-up records.

The franchisor records may be broken into the following sections: start-up or turnkey costs, funds available, equity available and investment cash, pro forma income statement, pro forma balance sheets, pro forma cash flow statements, break-even analysis, ratio analysis, and provisions for taxation.  These records need to be developed for both the franchisor's system as well as the individual franchisee unit system.   

Start-up or Turnkey Costs

The franchisor should list down all start-up or turnkey costs required to actually start the franchising system.  Many franchisors believe that all you have to do is say franchising and you go out and sell franchises to friends, relatives, or neighbors.  This is not true.  Franchising is regulated by the U.S. government through the Federal Trade Commission and certain regulatory requirements require financial outlays even before franchising is started.  Part of the start-up costs for franchising would be the legal costs which include the development of the Uniform Franchising Offering Circular (UFOC) and the franchise agreement or contract.  These legal costs have been known to be anywhere from $10,000 to $60,000.  In addition, other start-up costs may include separate land and building, as well as staff, before beginning the franchising process.  It is quite often that the franchisor will bring aboard someone specifically to direct the sales component of the franchising system as well as someone to direct the development of the operation system for the franchising program.   

Pro Forma Income Statements

The major accounting records kept by a franchisor and a franchisee at the very least would include:

(1) the income statement (profit and loss statement)

(2) the balance sheet

(3) cash flow statement

These three financial statements provide valuable information for the franchisor to make the correct financial decisions concerning the initiation, growth, or expansion of the franchise system.   

  Income Statement

The income statement (profit and loss statement) is simply a record of the revenues and expenses developed by the business in a given time period, generally one year.  The profit is shown on the income statement through the identification of sales from  which expenses are subtracted leaving the profit.  The income statement is usually prepared on a monthly, quarterly, or yearly basis and indicates the profit/loss relationship resulting from the sales and expenses incurred by the business.   

Balance Sheet

The balance sheet is an accounting statement which is a "snapshot" of the financial condition of the franchise business at a specific period of time.  This financial statement relies on the basic accounting equation and is often called a "statement of financial position of the business."  The accounting equation is:

          Assets = Liabilities + Owners Equity  

The balance sheet differentiates between money used by the franchisor for a short period of time -- less than one year (current assets), and money used for longer periods of time -- more than one year (fixed assets).  The balance sheet will also indicate the different between the monies received from creditors or loans (liabilities or debts) and funds put into the business by the owners (owner's equity, investment, or retained earnings).   

Cash Flow Budget Statement

Probably one of the most useful financial statements used by franchisors or franchisees is the cash flow budget statement which indicates the flow of money through the business.  The cash flow statement is generally developed on a monthly basis and depicts the business over a period of time on a monthly basis generally from one to five years.  The monthly cash flow statement indicates all cash received as revenues and cash expended as expenditures.  The net total is the cash flow or "profits" of the business during that time period.  The cash flow statement (pro forma statement) anticipates the short falls of money during specific seasons or cycles of the business.  The cash flow statement allows the franchisor to see when funds will be short or when there may be an excess of funds.     

Break-even Analysis, Ratio Analysis and Taxes

The break-even analysis refers to that point in the franchise business when revenues (income) exactly equal expenses (costs of doing business).  This financial position is often expressed in mathematical equations or in line graphs with separate lines representing variable costs, fixed costs, and total revenues of the firm.  At the point of the intersection of the total costs and revenue lines, the business is neither making nor losing money and is referred to as the break-even point. 

The ratio analysis is a method of determining the financial strengths or weaknesses of the franchise business.  Ratios may be used by the franchisor from one year to the next to determine if business is growing or failing.  Financial ratios may also be used to compare one business against another and ratios are often used by franchisors to compare one franchisee with another franchisee.      

The franchisor should also look at provisions for taxes which must be paid.  These taxes should include federal, state, social security, workman's compensation, sales taxes, business taxes, property taxes, and employer related taxes.  All businesses need to work and adhere to the taxing liabilities in their state and nation.