David Campbell’s five-part series ‘How to Optimise Franchisee Returns‘ series assists franchisees and franchise management professionals to improve their financial management capabilities and skills. This article looks at the management of expenses as one of the key elements that enable franchise business viability.
As a general rule the two major expenses (apart from cost of goods) in a business is occupancy and labour costs.
In some cases these two expenses can represent 40% to 50% of sales which in the case of a margin result of 70% would only leave 10 to 20 cents in the dollar to meet all other expenses plus profit after allowance for royalty and marketing fees. In this type of scenario volumes would need to be sufficient to generate sufficient profit dollars rather than profit percent.
To further highlight these conditions it is often helpful to simplify the Profit & Loss analysis by breaking down the actual distribution of each dollar of sale. For example a business performance could be represented as follows:
- Sales $700,000
- COGs 35 cents
- Margin 15 cents
- Labour 25 cents
- Franchise 08 cents (Fees)
- Other costs 2 cents
- Profit 05 cents or $35,000
Therefore, if a franchisee wishes to increase the percentage return from the business there are only really three areas:
a. Improve margin
b. Reduce labour or improve productivity
c. Lower the level of other costs
Of these, productivity is probably one of the biggest issues facing most businesses in today’s environment.
Managing staff costs can be as simple as measuring three ratios:
b. Unit cost
c. Cost per hour
Productivity is the measure of labour efficiency. What return am I getting for the cost being paid? Most businesses try to relate this measure back to volume or activity. However, we actually pay our staff to not only generate sales but also at a target margin. In essence we want our staff to make the sale, with an upsell, generate the order quickly and correctly first time without wasting inventory.
The productivity ratio is:
Gross Margin Dollars/Full Labour Costs = Productivity ratio
Each business is slightly different but a ratio of between 2 and 3 seems to be in the average range. Around 4 is peak productivity while fewer than 2 can indicate efficiency issues. An indicative example from a recent project we carried out showed that for every 0.1 movement in this ratio equated to a profit movement of $10,000.
Unit cost is the average cost of each rostered labour hour. The formula is:
Full Labour Costs/Total Rostered Hours = Unit Labour Costs
This is a good way to test if the labour rate is increasing or decreasing. A recent trend we have witnessed is that some businesses are effectively reducing the unit costs by employing, for example more junior staff. The pay rate is less but often productivity suffers as a result and can be tested by the next ratio.
Cost Per Hour
Cost Per Hour is the average hourly cost of the roster. The formula is:
Full Labour Costs/Total Trading hours = Average Hourly Labour Cost
This ratio allows you to test whether the week to week roster is costing more or less. In the above example where a higher mix of junior labour is engaged you would expect to see the average hourly rate reduce. However, often the reverse is true and you see an increase in the hourly rate as more junior hours are required to achieve the same level of activity. These ratios help determine the optimum staffing levels and mix.
Finance Training for Franchisees
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*David Campbell is the Director of Avatar Consulting and currently works with FranchiseED to facilitate our franchise finance workshops.