Slowdown? Time to Ramp Up Financial Monitoring and Planning
Rick Chittley-Young, Partner
FranchiseVoice
Many franchise sectors are feeling the effects of an economic slowdown. Over the past few years, franchisors have leveraged the expanding economy, pushing hard to implement growth strategies.
An economic downturn provides an opportunity to slow the pace, step back, and take a closer look at the financial health of your franchise system and your franchisees. By focusing on identifying and strengthening weaknesses, when the economy gears back up, your franchise can be strong and well positioned.
Monitor and Support Franchisees
Since lenders become more risk-averse during economic slowdowns, many franchisors experience fewer inquiries from potential franchisees. Loan requirements of banks, for example, become more restrictive. Typically, they advance fewer funds and demand more collateral and personal covenants. For franchisees considering a major financial investment, the risks can outweigh potential rewards.
When fewer new franchisees are coming on stream, franchisors have an opportunity to focus attention on existing franchises. Personal visits to franchise locations can yield valuable insights regarding the franchisee experience – the challenges they are facing, the support they need, and successes that may be shared with other franchisees.
To monitor the financial health of franchisees, ensure that your accounting system is producing timely information related to their sales, expenses, daily cash position, accounts payable and receivable, inventory and financial performance. Where your franchise agreements include controls over the form and timing of financial reporting, ensure that franchisees are complying, with prompt submissions of weekly or monthly reports.
Be on the lookout for changes in profitability, liquidity or efficiency among franchisees. Each month, examine the balance between cash inflow and outflow in cash flow statements; shifts in sales, gross profits, expenses or net profits in income statements; and changes in liabilities or net worth in balance sheets.
On a quarterly basis, review key performance indicators for your industry sector such as the following, to evaluate how your franchisees are faring:
- sales, year to date
- gross profit margins
- cost of sales as a percentage of sales
- labour rate as a percentage of sales.
Often, the first signs that franchisees may be struggling are late payments for royalties, government remittances, or rent. It’s important to ensure franchisees are making these payments on a timely basis, especially as franchisors may be liable for certain unpaid remittances. Ensure that a member of your accounting department is responsible for doing so or allocate responsibility to an external accounting firm.
When you do spot a franchisee with financial troubles, take immediate steps to identify causes and possible solutions. The earlier you address problems, the more likely it is they can be resolved.
Plan to Strengthen Financial Health of the Franchise System
This is also an ideal time to revisit your business plan. Consider where you are making progress and achieving successes. Identify obstacles to goals and strategize possible solutions.
Examine your financial projections. Do profit and loss forecasts identify anticipated sales and expenses? Projected balance sheets anticipate your financial position through this year and the next two to three years? Cash flow forecasts estimate the amounts and timing of cash expected to flow into and out of the business in the coming year?
Every month, compare your financial statements with these projections to monitor trends, establish profitability benchmarks and determine whether you are achieving your goals. Have you accurately identified slow cash periods? Properly budgeted for cash requirements? Planned for capital improvements? Appropriately estimated financing requirements?
It’s also important to track key financial ratios. Following are some of the most important for assessing profitability, liquidity and efficiency. Take a look at these every quarter, at a minimum.
- Gross margin
- Net profitability
- Average number of days for payables
- Average number of days of receivables
- Debt-to-equity
- Current assets / current liabilities
- Inventory turnover
Of course, slowing cash flow is a worrisome vulnerability during economic slowdowns. Be especially vigilant regarding liquidity. Always know your current cash balance. And never dip into operating funds to finance expansion as this can be a slippery slope that can lead to serious cash shortages.
In fact, it’s important to preserve cash. Review expenses and look for opportunities to reduce spending. And be cautious about expansion. Lenders have tightened credit and you may not be able to secure the same amount of financing at the same rate as you have in the past.
But don’t spend all of your time focusing on the bottom line. A down cycle is a good time to look up and invest in the future of your franchise system. Research and development can yield new products, new services, new production methods, and new distribution channels that may advance your long-term success.
The government will even help you develop these innovations. Both the federal and provincial governments offer generous tax incentives to companies that participate in research and development that produces new or improved products or processes. Eligible current and capital expenditures (including wages, materials, machinery, equipment, facilities and some overhead) are fully deductible and are eligible for investment tax credits. These are 35% for current and capital expenses of up to $3 million and 20% above that amount for Canadian controlled private corporations.
R&D specialists can quickly determine whether the work you perform may qualify for these incentives – or how to structure your activities in order to qualify. They can also provide support in preparing the relevant documentation and claim forms, as well as responding to audits and queries by the Canada Revenue Agency.
Therefore use this economic slowdown strategically: monitor and assist franchisees and strengthen your franchise system. When the economy ramps back up, your franchise will be well positioned to exploit fresh opportunities.
Rick Chittley-Young is a principal 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. You can reach Rick in the Oakville office at (905) 844-3206 or rchittley@bdo.ca.
