Ask A Financial Expert
Ask A Financial Expert
(FranchiseCanada, September/October 2003)
Q: Our accountant noticed that a couple of our franchisees were late paying their government source deductions and suggested we need to overhaul our accounting system. Why are these late payments such a big deal?
A: If you think of unremitted source deductions as the dead crows of cash-strapped businesses, you will appreciate why they are a big deal.
Just as dead crows are often an early warning sign of the arrival of the West Nile Virus, unremitted source deductions are often an early warning sign that a franchisee may be in serious financial trouble.
When cash flow becomes a problem for a franchisee, government remittances are often the first payments that the franchisee delays. Typically, this is because it may be several months before a government representative contacts the business to request payment, whereas other late-paid bills often generate more immediate and perilous responses from suppliers, such as ceasing delivery of essential supplies.
Once government payments are late, however, payments due to the franchisor, such as those for royalties and advertising, are soon likely to follow. This is why your accountant suggested an accounting system overhaul.
Every franchisor needs procedures and controls that will alert you to franchisee financial problems on a timely basis, when you may be able to circumvent – or at least minimize – the damage to your own business. The sooner you know that a problem exists, the more options are available to you.
If it’s six months before you learn that a franchisee has been missing payments, the problems may have already spiralled out of control – and your business may also take a hit from the fallout. Far better to implement your own early radar system to monitor franchisee profitability. Following are the basic components of an effective franchisor financial system.
Collect and review franchisee balance sheets and profit and loss statements on a monthly basis
The balance sheet portrays the financial position of a franchisee at a particular point in time – generally at the end of a month, quarter or year. The document summarizes assets, liabilities and net worth, showing what the business owns and owes. It also provides a good picture of what financial resources are available to pay liabilities.
The profit and loss, or income, statement depicts the operations of a franchisee over a specific period of time – generally a month or a quarter. This document gives the franchisor a good overview of the unit’s sales, gross profits, expenses and net profit – or – losses – for that period.
Analyze key financial ratios on a monthly basis
Certain financial ratios enable the franchisor to assess how well each franchisee is performing. The financial statements serve as the foundation for establishing profitability benchmarks. Among the ratios that are most helpful for a franchisor to monitor the financial health of its franchisees are: sales for the year to date, gross profit margins and cost of sales and labour rates as a percentage of sales.
Once you’ve determined these ratios, you can regularly track and compare them among all your franchisees – and with other franchises in your industry. This enables you to proactively monitor the performance of your units against industry standards.
Monitor government remittances on a quarterly basis
Remember that bellwether of financial stability: source deduction remittances. Every quarter, collect from your franchisees copies of their government remittances, including GST, PST and all employee source deductions. If a franchisee is late submitting these documents to you, this should alert you to a possible cash flow problem.
Consider outsourcing your accounting
The more experience that you and your accounting staff have with financial problems and solutions, the more likely it is that you can prevent a financial meltdown of your franchise network. Unfortunately, however, the owners and accounting staff of most new or small franchise systems do not have the time or expertise to design and implement the best possible reporting and control systems.
For this reason, you might want to consider business process outsourcing (BPO) of your accounting – a trend that is quickly gaining momentum following the recent wave of corporate financial scandals.
An accounting firm experience with franchises can manage bookkeeping, general ledgers, compilation and review of financial documents and statements as well as monitoring of franchisee profitability. Among the benefits of outsourcing over in-house accounting:
- Identify vital areas to focus systems and process controls;
- Fast, cost-efficient delivery of complete and accurate information;
- Standardized procedures and reports that conform to government regulations and that simplify monitoring and evaluation;
- Greater financial accountability, credibility and transparency, and
- Ongoing maintenance and monitoring of systems and controls to adapt to changing operating and legislative requirements.
With good financial systems in place, reliable benchmarks established and a close eye on franchisee profitability, franchisors can focus on what you do best: successfully growing your business.
Rick Chittley-Young, B Comm, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca), one of Canada’s leading accounting firms, which helps entrepreneurs succeed. Rick, who is located in the Oakville office, helps franchisees and franchisors launch and expand their businesses. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick at tel: 905-884-3206, fax: 905-844-7513, e-mail: rchittley@bdo.ca, or 151 Randall Street, Oakville L6J 1P5.
