Franchising encompasses a myriad of systems comprising retail, food, services, fitness, etc. All these business have a different range of margins which means that, for a business to be successful, sufficient volumes and “bankable margin” need to be generated in order to cover the fixed costs such as labour and occupancy costs.
Additionally, because of the volume or customer numbers required, staffing levels can be more intensive then for example, a retail outlet. Also depending on the business offer, the customer traffic can come in waves – morning, lunch and after work further compounding the peak staffing requirements.
Consequently, a new franchisee is faced with not just learning the operational aspects of the business but also the immediate and crucial demands of managing the staffing roster, the inventory, which can come with a specific use by date, menu/product range/service quality and customer satisfaction while at the same time ensuring sufficient working capital is available to meet all the obligations of the business.
As we have mentioned in previous articles the most crucial time for a new business is the first 6 to 9 months. Our research indicates that while businesses fail generally in year 3 or 4 in most cases the performance issues can be traced back to the first 6 months.
Most Franchisors provide comprehensive training to new Franchisees on the operational processes of the business model but despite this we still experience a high number of Franchisees who, while understanding the day to day process, lack a clear understanding of the targets and timelines they need to achieve in order to build a sustainable venture that will deliver an acceptable return on investment.
Over the next four articles, we will look at the elements that enable franchise viability. In the first article we will talk about Return on Investment.
Return on Investment
Most Franchisees have a reasonable expectation that the franchise investment will initially provide them a wage commensurate to the hours they work in the business and then over time a fair return on their investment.
As a simple rule and using the standard franchise term of 5 plus 5 we suggest that Franchisees should look to pay down the related business debt in the first tranche of the franchise. In order to accomplish this, an average ROI of 30% would need to be achieved by the business over the first 5 years. The rationale behind this is that if you deduct the average company tax of 30% the net ROI is 21%. 21% by 5 years equals 105% sufficient to repay the initial capital investment.
However, in calculating this number it is important to factor in the true and full cost of the venture; in other words, the total funding requirements for the Franchisee. As a guide this could include:
- Franchise fee
- Training cost
- Legal and accounting fees
- Lending set up costs
- Fit out
- Equipment and furniture
- IT set up
- Initial marketing spend
Once these costs are known, then and only then can the initial working capital provisions be established. However this reserve is often under estimated causing cash flow pressures and management stress in the early days of the business.
In these circumstances it is not uncommon to see Franchisees make myopic decisions such as reducing labour and advertising which often exacerbates the situation placing owners under more strain as they have to work longer and longer hours in the business.
Effectively calculating working capital for a new venture involves:
- Understanding what financial obligation the franchisees will depend on the business to service – lifestyle, personal debt
- The sales breakeven point
- Your model’s spool up rate (how quickly a franchisee can achieve model benchmarks)
Achieving sound ROI equates to a strong business model ensuring franchise engagement and compliance.
‘How to Optimise Franchisee Returns’ series:
Part One: How to Optimise franchisee returns – Return on Investment
Part Two: How to Optimise Franchisee Returns – the Breakeven Formula
Part Three: How to Optimise Franchisee Returns – Generating Sales
Part Four: How to Optimise Franchisee Returns – Margin
Part Five: How to Optimise Franchisee Returns – Expense
Have you enjoyed this series? Did you find it helpful? We want to hear from you – send us your feedback via firstname.lastname@example.org.
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*The author is David Campbell, the Director of Avatar Consulting and currently works with FranchiseED to facilitate our franchise finance workshops and masterclasses.