Looking to start a new franchise opportunity? Not so fast, there are many things to consider and plan before diving in.
“How much money can I make?” is far and away the number one question prospective franchisees ask me. It is a logical question to ask, but often a very difficult one to answer. There are many factors that play a role in estimating the potential revenues and profits of any business, and ultimately what your “take-home” income might be.
In franchising, there are often significant differences in profitability between different business concepts and industries, and many other factors including location, market, operating experience and the economy come into play.
One of the biggest mistakes I see new franchise business owners make is equating business profits with personal income; which leads them to enter into franchising with unrealistically high financial expectations.
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In many cases, a franchisee’s personal income is significantly lower than the profits that their business might generate. This is due to a variety of things including loan payments, required business reinvestment, and taxes; all of which get paid out business profits before a franchise owner can “pay themselves.”
Having a good understanding of how cash flows through a business is critical before investing in any franchise.
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When we crunched the data from the 28,500 franchisees we surveyed for Franchise Business Review’s 2015 Top Franchises Guide, we found that their average annual pre-tax Income was $80,000. However, we know that average numbers can be very misleading since a few top-performing franchisees can artificially inflate them. When we looked at the median annual pre-tax Income for the same group of franchisees, it was actually under $50,000 per year. The bottom line is that many franchisees earn far less money than they had originally planned because they failed to do their homework.
The Good News
The top 200 franchises listed our annual Top Franchises Guide significantly outperformed their competitors when it comes to meeting the financial expectations of their franchisees. On average, we found that franchisee incomes in these top brands are 15%-20% higher than other brands. In addition, in terms of your “upside,” the frequency of franchisees earning $250,000 or more was also 20% higher among our top 200 franchises.
When we whittled down the number of franchisees we surveyed to just over 6,000 who own three or more same brand franchises, the revenue figures changed. The median annual pre-tax Income of the multi-unit franchisees was $88,000. 29% earned more than $150K and 16% earned over $250K.
Crunching the numbers to try to estimate how much money you can potentially make by investing in a particular franchise can be challenging. For starters, you’ll need a basic understanding of accounting and to be comfortable reading and creating simple financial statements. An entry-level small business finance course at your local community college is always a good option for people who may be a little “numbers challenged”.
Once you have a good understanding of an income statement, which is often called a Profit & Loss Statement, as well as a balance sheet and how the two interact, you’re ready to start you financial analysis of a franchise opportunity.
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Things to Consider Before Investing
There are 11 key financial questions you should answer before investing in a franchise:
- What are the total estimated costs to open the business?
- How will I finance these initial costs?
- How and when will I pay back any loans?
- How does the business generate revenue? What are the key business activities that drive sales/revenue?
- Once open, how long will it take to start generating positive cash flow?
- What are the typical expenses and on-going fees of the business?
- What’s my Plan B if things take longer than expected and I need more money?
- Assuming all goes well, what will the business be worth in three, five and ten years?
- What additional capital investment will the business require over time?
- Are my financial expectations for the business consistent with the experiences of most franchisees?
- At the end of the day, will the business yield a decent return on your total investment that is comparable to other investment opportunities?
The Franchise Disclosure Document (FDD) will help shed light on some of these questions. Items 5, 6, and 7 of the FDD covers initial fees, other fees (i.e. royalties, advertising, etc.), and the total estimated initial investment. Item 19 of the FDD, also called Financial Performance Representations (FPR), will provide information related to the actual financial performance of the franchise at the business unit level. It is important to note that not all franchise companies provide financial performance information in their Item 19, and those that do, typically only disclose gross sales/revenue, not profitability. To determine profitability, the cost of labor, rent, supplies, insurance, royalties, ad fees and all other business expenses must be deducted from the sales figure.
It is crucial to create a projected five to ten year financial plan for the franchise opportunity you are considering using an Excel spreadsheet or similar format and to speak with existing franchisees about their experience in order to have a realistic view of how much money you can expect to earn. Doing so will help prevent you from investing in an average, or worse, below average performing franchise, and instead increase your chances of joining the ranks of the thousands of successful franchisees who help drive our country’s economy.