Entering into a franchise agreement may be the best business decision you ever make. However, it’s important to look at its long-term potential rather than seeing it as a trade-off of hard earned money and/or going into debt in return for a lifestyle with a modestly paying job, warns Andy Graham, Managing Partner – Brisbane and Director, Business Advisory, RSM Australia.

Whether it’s against their better judgement or not, one thing many franchise operators don’t do every pay cycle is draw down a ‘market value wage’, along with any staff they employ. But as important as receiving a regular wage is, that’s only one of three imperatives that any successful franchise operator should expect from their business. Equally important, any business, be it an SME, franchise or large corporation should aim to make an adequate profit return after market value wages to owners and maximise the return on capital investment should it decide to sell the business.

Busy treading water? franchise agreement

While Franchisors are pretty upfront about what it's going to cost to get you into their systems, you should ensure that they also tell you what a good profit looks like. Whether you’re new to running a business, or have been doing it for decades, it’s critical to recognise that being frantically busy doesn’t necessarily mean you’re making a profit.

Similarly, it’s important to realise that profit isn’t just the money received from customers for the goods you sell.

The profit is simply what’s left after revenue from business activity exceeds the expenses needed to keep the business going or to put in another way; profit = total revenue – total expenses. This may sound like business 101, and too pedantry to mention. But the sad reality is that too many franchisees struggle with becoming and remaining profitable.

Just as your household can’t go on forever without you pulling a wage, no franchise is sustainable if it doesn’t turn a positive net profit. It’s profit that allows you to continually reinvest in your business, and will go a long way to helping you secure financing from a lender or attract investors to fund future operations or growth and expansion plans.

Understanding your financial position

There is a myriad of reasons as to why you might be making a loss and the sooner you can get to the bottom of it, the better. If there’s any doubt as to the financial position of your business, at any time, but especially at tax time, then bad accounting could be the root cause of your problems. No franchisee can run their business unless they have a complete financial snapshot of the business in real-time, and cloud-based accounting is an effective way to ensure you achieve this.

If one of the reasons you’ve been attracted to a franchisor is the quality of their systems, then bad accounting and access to the financials is unlikely to be an issue for you. However, that doesn’t mean future earnings forecast within the franchisor’s disclosure documents haven’t been overly optimistic. Consequently, franchise fees could be one of your biggest issues if they don’t represent value for money for what you are receiving especially within a down market where the cost of doing business is going up.

Royal Commission is a game-changer profit

If you’re a franchisee who’s struggling to either make and/or maintain profitability, then you need to prepare for the net negative fallout from the recent Royal Commission into banking. Like it or not, it may become even harder for franchisees to get credit as banks become more mindful of operating within increasingly tighter rules being imposed by government and other regulatory bodies, notably APRA and ASIC.

With the time it takes banks to make judgement calls on loan applications likely to be considerably longer, franchisees that are used to making swift decisions, may find their ability to capitalise on new opportunities is diminished. Thirdly, assuming you are able to acquire bank funding, the cost of accessing the account facilities and payment services you’ve come to expect are likely to be higher, as bank charges rise in an effort to maintain their profit margins.

Then there’s the very real possibility that interest rates may go up, even before the RBA begins a new rate rise cycle, as banks respond to pressures from both the Royal Commission and what’s happening offshore, notably the U.S.

Understand your options franchise agreement

The good news is that there is now a growing plethora of alternative funding sources available to franchisees. Step one is to make sense of all the options available in the SME finance space. These include unsecured finance from non-bank lenders, new Fintech-type organisations, foreign lenders, through to crowdfunding, private equity, factoring, peer-to-peer lending, and government-backed mortgage securitisation schemes.

The next step is to understand how each of these different funding options work. Half the battle is knowing what stages of your business’s life-cycle might complement faster and more flexible non-bank lending options, like when you’re going through a period of transition or high growth.

But given that non-banks – which are not currently controlled by APRA – typically don’t require SMEs/franchisees to jump through as many hoops, it’s equally important to know when they’re likely to do more harm than good.

Remember, both bank and non-bank lenders have useful tools that are freely available online from the comfort of your own office. However, when trawling through the burgeoning number of online lending opportunities aimed at SME operators, make sure you know who you’re really dealing with and their connections to other financial entities.

Five tell-tale signs of an unprofitable franchise

1. The business is not a sound financial proposition

In other words, you’ve been sold a pup and the money you will need to make to cover overheads such as rent, wages, cost of goods, utilities and loan repayments is simply unrealistic. Admittedly, all franchise owners work hard, but if sacrificing your marriage and family life has become a permanent lifestyle then you need to honestly assess whether this is sustainable long-term.

2. Difficulty in accessing financial data financial data

Many franchise operations come with financial reporting software that franchise owners must use. Owners should be able to get access to real-time financial information to track their income and expenses.

3. Lack of qualified, dedicated people to handle the books

Unlike many other areas of the franchise, bookkeepers don’t require certification and it's commonplace for businesses to rely on a family member, someone on contract or also juggling other duties, to perform this role. Whilst bookkeeping principles are fairly similar, each franchise will have its own quirks and the bookkeeper will need to be across the different financial reporting technologies that would best suit that franchise. It’s important for business owners to work with their accountants and bookkeeper and take an ‘active interest’ in the financial date produced – not just have an eye on the balance in the bank account.

4. Unreasonable franchise costs

All franchisees have franchise fees payable, which typically cover marketing costs and administration fees. Franchisees need to understand the fees that they are paying, and what they get for those fees. They need to make sure they get value for money and use the services provided by their franchisor.

5. Poor franchisor purchasing agreements

It is common in franchise business structures, for franchisors to negotiate deals with suppliers, and then on-sell inventory items to the franchisees. Franchisees need to regularly review these costs to ensure that the amounts paid for their stock is better than if they source the same items themselves from other suppliers. Notwithstanding most franchise agreements will likely require the franchisee to purchase exclusively from the franchisor.

This article first appeared in the Business Franchise Australia and New Zealand magazine’s July 2018 edition.