Becoming your own boss might be the key factor for many people in deciding to buy a franchise, but it’s the profitability and financial performance of the business that provides real satisfaction for franchisees.
And while the business model is important in determining profitability, it is often the franchisees themselves that are their own worst enemy in achieving a healthy bottom line.
A review of the financial performance of franchisees in just about any system will reach the same conclusion: franchisees who fail to plan, plan to fail.
Franchisees who don’t understand the financial drivers and performance of their business are like people riding bicycles while looking backwards – it’s possible to go forward for awhile, but it’s bound to end in grief.
Key Performance Indicator (KPI) # 1: Calculate your living costs
One of the biggest problems is that many people going into business for themselves for the first time, (whether franchised or independent), rarely take the time to work out what they need to achieve from the business just to cover their living costs.
The first thing is to work out what it costs to stay alive – to pay the rent or mortgage, buy groceries, pay bills, put the kids through school, repair the car, save for a rainy day and so on. This can quickly add up to a surprisingly large amount for many people, and this helps set an essential business benchmark and it becomes the absolute minimum level of return (in terms of owner’s drawings and profit) that the business should achieve.
As simple as this might sound, a frightening proportion of people in business for themselves don’t know what it costs them to live, and therefore what their business should be providing them at a minimum.
Key Performance Indicator (KPI) # 2: Match the debt with the asset
When borrowing to buy a franchise, the term of the loan should be the same as the duration of the franchise.
This means that franchise buyers who draw against their 20-year home loan for a five year franchise (for example) are failing to account for the true cost of the interest over the term of the business. While at first the loan repayments for the extra sum borrowed for the business may seem lower, the business owner will be servicing the debt long after they have sold or left the business.
This is the same approach as ensuring that any lease for premises also matches the term of the agreement – usually around five years – but does not lock the franchisee into paying rent for years after the franchise has ended.
Key Performance Indicator (KPI) # 3: Business costs are business costs
Business owners often complain about poor profitability in their business, but a closer examination of the accounts commonly reveal a lot of personal expenses that are put through the business and which artificially reduce profits. In many cases, the owners have made a conscious decision to load the business with as many personal expenses as possible to reduce increase tax deductions and to reduce tax on profits.
In reality though, these costs are owner’s drawings in a different form. Once they are added back, the business can usually demonstrate greater profitability in keeping with the business model.
An unfortunate byproduct of loading personal expenses into a business to reduce its taxable profits is that it also reduces the ultimate sale price of the business.
Businesses are bought and sold on their ability to generate profit, and so a business that shows little or no profit will be worth much less to a potential buyer than the price the seller usually wants.
Key Performance Indicator (KPI) # 4: Pay yourself what the job is worth
In some cases, franchisee profitability is under or over-reported because franchisees don’t either pay themselves enough, or pay themselves more than the business can bear.
For example, a husband and wife couple might show a larger profit for the year, but failed to allocate themselves as a cost to the business. In other words, they didn’t draw a wage or salary, and simply counted the entire surplus at the end of the year as their profit.
This creates a false profit and fools business owners into thinking the business is more profitable than it really is.
In contrast, people who might have had $100,000 per year jobs in the workforce and who continue to pay themselves at that rate when they first start a business could be heading for trouble, especially if the market rate for the job of managing that business might be only $50,000 per year.
By paying themselves an unsustainably high amount, these business owners reduce the profits of the business by $50,000 a year and may cause it to show a loss. Many owners fail to pay themselves what the job of running that business is otherwise worth on the open market, and this can distort their profit figure.
Key Performance Indicator (KPI) # 5: Get the margins right
Margins added to the cost of goods or services in some franchise groups can vary by as much as 40%, resulting in wildly different profit results for businesses that are outwardly similar, but operationally diverse.
A system-wide benchmarking process can allow franchisors and franchisees to identify businesses, products and services with the greatest margins, and learn from these for the benefit of the network. Franchisors are often too focused on a franchisee’s top line sales, especially if the franchise fees are calculated as a percentage of turnover. However, a focus on a franchisee’s bottom line is just as important to ensure the long-term viability of the relationship.
Key Performance Indicator (KPI) # 6: Keep the expenses under control
Similar to a high spread in margins, the difference between high and low-performing franchisees in a group can come down to their expenses as a percentage of turnover.
Fixed costs such as rent, base labour and marketing (though some will argue this is not a fixed cost) can also vary dramatically across a network, and can vary as much as 30% between strong and poor-performing franchisees, whose high expenses rob them of profit.
Key Performance Indicator (KPI) # 7: Sell more
It’s not rocket science. Some franchisees can do it really well, and others are not so good at it, but being able to sell is fundamental to the success of any business. A quality benchmarking program will link sales success with promotional activity, and when highly-evolved, can allow franchisees to predict their likely sales increases from a given marketing activity.
Key Performance Indicator (KPI) # 8: 1 + 1 + 1 = A lot more than 3
By getting the margins right, keeping costs under control and increasing sales, franchisees can achieve an exponential lift in profitability. Simply increasing prices by 1%, reducing costs by 1% and increasing sales by 1% can potentially result in a 26% increase in profit.
Asking a business owner to increase their performance by 26% is impossible. But a 1% improvement here and there should be possible for just about anyone, and can help generate handsome profits.
The final word
What gets measured gets done. Benchmarking and financial management is not a burden for business if it can find ways to lift bottomline performance. To do this effectively requires commitment and discipline. Most importantly, it requires system-wide implementation and management, which not only can help franchisors boost franchisees’ bottom lines, but also identify those franchisees who may need intensive care. A franchise system that can proactively monitor franchisee performance and be on standby to assist even before franchisees themselves realise they need help is a sustainable system indeed.
The Franchise Advisory Centre is holding franchise benchmarking workshops in Sydney and Melbourne on September 23 and 24. The workshop explores the issue of franchise system benchmarking and the need for improved financial monitoring to lift franchisee and franchisor profitability. Click here for details.
Jason Gehrke is a director of the Franchise Advisory Centre and has been involved in franchising for 18 years at franchisee, franchisor and advisor level. He provides consulting services to both franchisors and franchisees, and conducts franchise education programs throughout
Smart Company is the leading online publication in Australia for free news, information and resources catering to Australia’s entrepreneurs, small and medium business owners and business managers.
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