Smart Accounting Practices Drive Automotive Franchise Success
By Rob Wilkes, Partner
BDO Dunwoody LLP
Let’s start with the good news.
If you’re thinking of investing in a franchise in the automotive sector, here are a few encouraging facts. Canada is among the world’s leading automotive producers, has a large dealer network and an extensive aftermarket sales and service sector. More than 500,000 Canadians are employed in automotive assembly, component manufacturing, distribution and aftermarket sales and service.*
Moreover, the future looks bright. Demand for products and services associated with owning a vehicle continues to grow and governments have committed to generous capital cost allowances, investments in transportation infrastructure and measures to foster innovation and green technologies.
As our society becomes more mobile and people travel and move more often, they are seeking out familiar products and services – and automotive franchises provide that name and reputation recognition.
New services, products and franchising models are also enabling more franchisees to enter the automotive sector – and at a lower cost than in years past. These range from car dealerships and rental car agencies to retailers selling parts, to repair shops specializing in brakes, transmissions or windows, to franchises offering painting, oil changes, tune-ups, installation of tires and accessories, detailing or car washing. Today, franchisees can get up and running with small, specialized operations for as little as $50,000.
More good news: since many people consider vehicle ownership to be a basic necessity, automotive franchises tend to be less risky than franchises in other sectors. * Cars on the Brain: Canada’s Automotive Industry 2006 – Industry Canada
It’s important to provide a realistic picture by tempering the good news with some of the challenges this sector faces – such as a tight labour market that continues to exert upward pressure on wages. And high costs for energy and raw materials which, along with the strength of the Canada-US exchange rate, are placing intense cost pressures on businesses. And rapidly evolving technologies, which demand ongoing investment in equipment and processes and employee skill development. And, of course, competition that just gets tougher and tougher – not only from local companies – but from the economic juggernaut that is China, whose exports to Canada grew 115% between 2001 and 2005.**
Despite these challenges, this can be a profitable time to enter the automotive franchise market. The economy is solid, there’s strong demand for local automotive products and services and interest rates remain low. The route to being successful is to focus as much on the financial management of your franchise as you do on your sales.
There are five important steps you can take to build the financial health of your franchise.
1. Start with the right accounting system
The right accounting system is the foundation of every financially healthy franchise. This system enables you to calculate sales and expenses, to monitor inventory and profits, and to flag any emerging financial problems. As well, some franchise agreements require franchisees to meet specific performance requirements; failing to do so can lead to penalties. Therefore it’s very important to become knowledgeable about the financial performance of your business.
The components of an effective accounting system include selecting the appropriate accounting method, purchasing the right software, inputting accurate information and generating timely financial reports.
Your franchisor or accountant can provide you with expertise and guidance in each of these areas. They can advise you, for example, as to whether the cash or accrual basis is the appropriate accounting method for your particular business and the kind of financial information that you need to make informed decisions. They can also advise you on the software you will need to monitor sales and expenses and to handle invoicing, payroll and government remittance requirements.
While some franchisors also provide their franchisees with bookkeeping services, if yours doesn’t and you don’t have the skills or the time, be sure to secure an experienced bookkeeper. This individual can help you organize and track receipts, cheques and other financial records and generate timely financial reports that are vital to you, your franchisor and your business lenders. **International Trade Brief – winter 2007 - Lang-Michener LLP
2. Monitor your business
The only way to really know how your franchise is doing is to regularly review your results. Three financial statements will give you a clear picture.
The cash flow statement records cash inflows and outflows over a specific period of time – typically a week, a month or a year. It helps you identify where your revenue came from and where you spent money. It can help you budget appropriately for your franchise and, if you have a business loan, it will enable your lender to determine your ability to repay the funds.
An income statement or profit and loss statement tells you whether your franchise is profitable or losing money. This statement records revenues and operating expenses for a given period – generally one month, one quarter or one year. Reviewing income statements regularly enables you to identify significant cost increases or profit decreases.
A balance sheet provides a picture of the financial condition of your franchise at a specific point in time. It measures assets and subtracts liabilities to calculate the net worth of your business. It can tell you whether inventories are high or if receivables are increasing.
Carefully review these statements – at a minimum, every month – and as soon after month-end as possible. Compare month-to-month and year-to-year statements to spot significant trends.
There are also three important financial ratios that you should calculate every month that will show you how well – or poorly – your franchise is doing.
Gross margin (sales – cost of goods sold / total sales) represents the difference between sales and the cost to make those sales and shows your profit before business expenses. As competition increases, gross margins are often squeezed and you need to know whether your margins are declining. If so, you may have to look at reducing costs.
Current ratio (current assets / current liabilities) measures the liquidity of your business – your ability to meet short-term debt obligations. If the ratio drops below 1:0, your franchise’s ability to pay bills may be at risk. To improve your current ratio, you can increase capital by acquiring financing or decrease liabilities by paying down some debts.
Debt-to-equity (total debt/net worth) compares the total debt of your franchise with its net worth and shows how you are using debt to grow your business. A debt-free business may not be able to expand, but at the other end, if this ratio approaches 3:1, your debt level may be getting risky.
If you note declining trends with any of these ratios, be sure to consult with your accountant as quickly as possible. Recognizing and acting on early warning signals may circumvent a crisis.
3. Watch cash flow
Companies that run out of cash are out of business. End of story. This is why it’s so important to watch your cash flow carefully and to do everything you can to efficiently bring cash into your franchise and keep it as long as possible. Effective cash management involves:
- billing promptly,
- paying bills only when they are due,
- quickly following up on overdue accounts,
- maintaining a contingency fund,
- investing surplus cash,
- borrowing funds at the best possible terms, and
- maintaining an optimal level of cash.
Be sure that you know what your cash balance is at all times. Every week, monitor sales and reconcile them to your bank deposits. Every month, review your cash flow statement and reconcile it with your bank statement. Also, review accounts payable and receivable and cost of sales to ensure ordering and pricing are appropriate. If relevant for your franchise, compare labour rates as a percentage of sales as well to ensure that your staffing is at the right level.
Keep in mind too that while it’s tempting for franchise owners to draw more salary as the business becomes more profitable, your compensation should not be first priority. You need to retain a certain level of cash in your franchise to sustain it during slow periods and to support its growth.
If your cash flow is irregular, you will need to predict the amount of cash you may require to cover expenses during slow periods. If you don’t feel qualified or comfortable to do this, ask your accountant to assist.
4. Actively manage your business and personal tax situations
When you work as hard as you do to develop a successful business and earn a good living, you don’t want to give away any more of your hard-earned funds in taxes than you have to.
This is why it’s so important to structure your business and personal taxes in order to reduce your taxes payable. For owners of small and mid-size businesses, personal and business taxes are intertwined. Having the counsel of an accountant experienced with small businesses can be invaluable in guiding you through the complex, ever-changing maze of tax legislation and business regulations. For example, this professional can provide advice regarding how best to structure your business: as a sole proprietorship, partnership or corporation. There are important advantages and disadvantages to each from of business, and making the right choice at the right time can mean the difference of tens or even hundreds of thousands of dollars over the life of your franchise business. Your accountant can also help you identify all relevant tax deductions and credits and establish a retirement savings plan that will achieve your goals.
5. Nurture your relationships with your lenders
Anyone who invests in your franchise – including family and friends – will want reassurance that you can make your business succeed. This means repaying them according to the terms of your agreement and keeping them informed about how your business is faring.
If you have a bank loan, know the terms of your agreement. If you fall out of compliance with a covenant, there is a significant risk that your loan could be called in, whether or not your payments are up to date. Your banking agreement may require you to maintain certain financial ratios to ensure that you can handle your loan payments, therefore you should track these ratios just as your banker will.
If it’s been awhile since you reviewed the terms of your lending agreement, take another look. As your franchise matures and becomes more profitable, you may be able to reduce personal guarantees or interest rates.
To protect your business from a future cash crunch, it’s also helpful to line up potential new sources of financing before you need the funds. Ask your franchisor or accountant to recommend or introduce you to appropriate lenders.
Following these five accounting strategies will put you in the driver’s seat – and keep you safely on the road to success for your automotive franchise.
Rob Wilkes is a partner of BDO Dunwoody LLP (www.bdo.ca). BDO is one of Canada’s leading accounting and advisory firms, which helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rob in the Mississauga office at (905) 272-7823 or rwilkes@bdo.ca.
