Financial Analysis

There is no such thing as a free lunch...

Before you buy a franchise, you must be aware of the costs involved, both tangible and intagible (e.g. rules and regulations put upon your business operations). Here are basic costs associated with running your franchise:

Franchise fees - This is an up-front fee required for the right to be a franchisee. The more successful and established a franchise is, the higher this fee tends to be.

Royalties - The franchisor receives a cut of the sales your franchise generates. Keep in mind that royalties are taken from sales not profits, so you pay the same amount regardless of whether or not you turn a profit.

Markups on equipment, goods and supplies - Franchisors often require you to purchase goods only from them rather than from outside sources. Other franchisors might give you permission to shop from outside sources, but there are a number of specific requirements you must meet. All this adds up to hidden costs that must be factored into your decision-making.

Training fees - Training programs may involve fees and traveling expenses incurred to attend training are often not reimbursed. Many factors make the completion of training programs a prerequisite to owning a franchise, making this a cost that cannot be avoided regardless of whether or not you actually need the training.

Advertising fees - Many franchisors run advertising funds that require all franchisees to contribute a percentage of sales. Aside from these nationally-run programs, there may also be co-op advertising fees that cover advertising for a regional group of franchisees. Lastly, many franchisors will not specifically ask for contributions, but will instead require franchisees to spend a certain amount on local advertising that must be approved by the franchisor.

Interest on financing - In order to purchase your franchise, you may have to finance a portion of your total costs, which may include but are not limited to the franchise fee, leasehold improvements or initial inventory. By financing, you will incur interest expense.

Leases - These costs will go either toward your franchisor, which is relatively uncommon, or a third-party real estate agent. Real estate includes mall space, warehouses, etc.

In order to promote the industry's attractiveness, most literature on the subject of franchising includes the same often-quoted, but very misleading, statistics that leave the impression that franchising is a near risk-free investment.

Don't be fooled! Always take the time to examine your costs and risks.

Show me the money...

Many franchisors include earnings claim statements (UFOC Item #19), which present sales, expense and/or profit summaries based on actual operating results for company-owned and/or franchised units. Since no official format is prescribed, the data may vary in degree of detail among franchisors. In addition, providing an earnings claim statement is strictly optional. Thus, less than 15% of franchisors supply one.

Franchisors are reluctant to provide financial information for a variety of reasons. They may feel that by doing so, the pool of prospective franchisees will shrink. They may also be cautious of "misrepresentation," in the event that franchisees view the financial statements as some sort of guarantee of sales or income for new units. Finally, it may simply be too costly to collect and distribute the data.

As an assist to prospective franchisees, Source Book Publications has recently published a book entitled "How Much Can I Make?" It includes over 165 earnings claim statements covering a diverse group of industries. It is the only publication that contains current earnings claim statements submitted by the franchisors. Please visit our bookstore for ordering information.

Next: Stage 2: Evaluation