Ask the Expert
Author: Marina Ponton
Date: June 2010
Publication: FranchiseCanada Magazine
Q: As a new franchisee, I’d like to do whatever I can to protect my franchise; what financial risk management steps are most important?
A: One of the attractions of owning a franchise rather than an independent business is the lower risk of business failure. However, that doesn’t mean that you shouldn’t take certain steps to protect the financial wellbeing of your new business.
While every franchise has different risk reduction needs, following are some fundamental strategies that can help to preserve profitability and protect valuable assets such as cash, receivables, inventory and equipment.
Protect Profitability
There’s revenue. And then there’s profit. While many new franchisees focus on the dollars flowing into their business, it’s what’s left after paying all of the expenses that determines the success or failure of a franchise. To measure profitability, you need to know your numbers. While the specifics will vary from one type of franchise to another, the following are some key financial metrics to assess on a daily, weekly and monthly basis.
Daily: always know your cash balance.
Weekly: compare total sales revenues with projections; review number of sales, average size of transaction (or average sale/customer or average order value), number of repeat sales, and planned versus actual expenses.
Monthly: compare profit and loss forecasts with balance sheets; review expenses to ensure they’re in line with the business model and with increases/decreases in sales; review gross profit/total revenue, gross profit/net sales, debt/equity, current assets/current liabilities, and cost of goods sold/sales.
Preserve Assets
The success of a franchise requires the preservation of vulnerable assets – both current (cash, receivables, inventory) and fixed (equipment).
Cash
It’s cash, not profit, which pays bills and loans. Thus efficient cash control is essential in order to track and balance spending and collections as well as to deter theft and fraud.
Start by ensuring you have sufficient cash to get your franchise up and running. Before signing a franchise agreement, every prospective franchisee should understand exactly what the business will cost. Underestimating the amount of capital required can quickly burden a new business with cash flow stress. Costs include franchise fee, pre-opening expenses, operating expenses to cover monthly overhead until the franchise generates sufficient profits (three to 12 months) and personal living expenses for one to two years.
Once the franchise is operating, the following strategies can help to ensure the business doesn’t lose or run out of cash.
- Make daily bank deposits.
- Conduct cash reconciliations daily (for cash-based businesses) or weekly.
- Prepare weekly (for cash-based franchises) or monthly forecasts for one year and compare with cash flow statements.
- Monitor accounts receivable every week.
- Review accounts payable monthly.
- Compare the average age of payables (payables/sales x 365) with that of receivables to assess the balance of cash inflows/outflows.
- Reconcile supplier statements with invoices.
- Reconcile monthly bank statements.
- Verify payroll recipients and amounts every month.
- Review expenses on a quarterly basis.
Receivables
While not at the top of most franchisees’ priority lists, the effective management of accounts receivable directly impacts cash flow and profitability.
- Establish and maintain specific credit limits for every customer.
- Invoice immediately and verify timeliness of invoicing on a weekly basis.
- Monitor accounts receivable every week to identify potential problem accounts.
- Issue monthly account statements.
- Calculate the average age of receivables (receivables/sales x 365) to measure the effectiveness of collection procedures.
- Immediately address overdue accounts: contact the customer, charge interest, stop shipment or appoint a collection agency.
Equipment & Inventory
Equipment and inventory represent a major investment of financial resources that needs to be protected.
- Perform physical inspections or reconciliations of equipment (especially small wares) and inventory daily, weekly, or monthly, depending upon the type of equipment and rate of inventory turnover.
- Measure inventory turnover (cost of goods sold / inventory / 365) to provide a benchmark for sales fluctuations.
- Compare inventory turnover with industry averages to assess the performance of your franchise.
Starting a new business never comes without risk. By implementing risk-reduction strategies like these, however, you can worry less about risk and focus instead on the success of your franchise.
Marina Ponton is a manager in the Burlington office of BDO Canada LLP, which helps entrepreneurs, family businesses, franchisors and franchisees succeed. You can reach Marina at 905-633-4928 or mponton@bdo.ca.
