Franchise Finance Basics

In my role at Franchise Foundry, I often have the opportunity to speak to franchisees about their financial statements. Financial management is a skill that is critical to successfully managing a franchise, but it is common for franchisees to have limited financial backgrounds. Their franchise may be the first time that they needed to be able to read a profit and loss statement. While I can’t cover everything you need to know to manage the finances of your business, here are three tips that most people I talk to would benefit from:

1. You can only manage what you measure.
When times get tough, it’s human nature to put your head in the sand. When you start managing your finances by what is in your checking account, you will find that there is less and less in the account. Even if times are tough (maybe especially if times are tough) pay close attention to your financial statements.

It is also important for your financial statements to be accurate. If you have a lot of expenses labeled as “Miscellaneous” or “Credit Card Charges” you won’t be able to get a handle on where your money is going. Knowing where your revenue is coming from is important too. If you have a few categories of revenue (food and clothing, for example) make sure that you break that out as well.

2. Know the difference between fixed and variable expenses.
Fixed expenses stay the same every month and variable expenses change depending on how much you sell, how much labor is required, etc. You typically have one shot at negotiating your fixed expenses (when you negotiate your lease, for example), but you can often work on reducing your variable costs over time. When you are starting a business, do what you can to keep fixed costs as low as possible. Low fixed costs means you have a lower break-even point — the point at which your revenues cover all of your expenses, but you make not profit.

3. Don’t mistake profit for cash flow.
I can’t tell you how often I have heard people say, “The profit and loss statement says I should have $XXXX, but there is no money in my checking account!” Make sure you are asking your accountant for a complete set of financial statements. This should include a profit and loss statement, a balance sheet, and a statement of cash flows. There are online tutorials that will teach you the basics of each of these documents, but for the purposes of this blog, I will tell you that the statement of cash flows will tell you if you generated cash this month or not. The profit and loss statement is intended to give you a basic overview of the health of your business. The idea behind modern double entry accounting is that we want to match expenses with the revenues they helped to generate.

Let’s take a simple example. Let’s say you need a computer for your business and that computer will probably help you operate your business for 2 years. If you were to pay $2,400 for the computer equipment, your bank account would show you paying $2,000 but your profit and loss statement would probably show an expense of $200 per month for each month of the 2 year lifespan of the computer. You would also see an asset on your balance sheet that would decline in value as you recognize the $200 per month on your profit and loss statement.

4. Track expenses as a percentage of sales.
I like to look at my monthly expenses as a percentage of sales and then compare those to industry averages. Most franchisors will share information with you and let you know how you stack up compared to others. If your labor cost is 30% while everyone else’s labor is averaging 25%, you know where to focus your efforts. Look at these expense lines as a percentage of sales by month and year to date. It’s also useful to look at how you did last month compared to the same month last year.

Finally, it’s important to understand the impact borrowing can have on your cash flow. That topic is complicated enough to warrant its own post. I will write about that next.

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