CHAPTER 5: FINANCIAL ASPECTS

OF A FRANCHISE
ESCABARTE
DAGPIN
DUHAYLUNGSOD
BACONGA
LINGO
HORTELANO
 ESTIMATING FINANCIAL
REQUIREMENTS
Financial requirements for a franchise business
may be classified into two basic categories as
given below:

1. Estimating 2. Estimating
Cost of Entry Cost of Operation
1. Location and Site Selection
A potential franchisee has to 1. Estimating
select a specific location and site Cost of Entry
according to the franchisor’s site A. Entering a New
Franchise
selection procedure.
-the cost of entering
new franchisee
includes expense
right from start up
expenses.
Table
 1. Estimating
2. Interior and Decoration
Cost of Entry
Plays a vital role in creating a
store layout and store ambiance. A. Entering a New
Franchise
-the cost of entering
new franchisee
includes expense
right from start up
expenses.
Table
3. Furniture and Fixtures
Some franchisees supply furniture on
their own or provide specification and 1. Estimating
a list of vendors from where the Cost of Entry
franchisees can buy furniture.
A. Entering a New
Franchise
4. Licensing and Permission -the cost of entering
It is important for a franchisee to new franchisee
obtain necessary license and official includes expense
right from start up
permission from competent authority, expenses.
in order to start the business.
5. Franchise Fee 1. Estimating
Some franchisors charge a franchise Cost of Entry
fees for their franchisees while A. Entering a New
signing the contract. Franchise
-the cost of entering
new franchisee
includes expense
right from start up
expenses.
Table
1.Valuation of asset of the 1. Estimating
business Cost of Entry
2.Valuation of goodwill and B. Entering an Existing
brand reputation of the Franchise
-cost of entering an
business. existing franchise
involves cost of
acquisition of the
business of an existing
franchisee.
2. ESTIMATING COST OF
OPERATION

*franchise involved considerable amount of

operating expense.
* Franchisee has to start from business promotion
activities to create awareness in the market.
Several Important Cost Heads:
a. Business Promotion Expenses
b. Training and Development Expenses
c. Inventory and Warehousing Expenses
d. Employee Related Expenses
e. Amenities related Expenses
f. Information Technology Related Expenses
g. Customer Relations Building Expenses
a. Business Promotion Expenses
• A franchise has begin with a local
advertising to mark its presence. Some
franchisor requires that the launch of
franchise must be done with a bang.
• A franchisee also has to provide sales
promotion activities to attract the customers.
Examples: Free offer, discounts,
demonstration, free samples and etc
b. Training and Development Expenses
Franchisees are expected to train people asper the requirement of
the franchisers. Some franchisers provide in-house training
whereas in some cases the franchisers direct the franchisees to their
designated professional trainers.

c. Inventory and Warehousing Expenses

* retail franchisee is supposed to keep inventory of
goods at store level as well as a buffer stock. For these, a
warehousing facility is also needed
 d. Employee Related Expenses
Employee related expenses include wages and salary,
insurance and other allowances to be paid to the
employees.

e. Amenities related Expenses

In order to create comfortable shopping
environment, certain
amenities such as air conditioning, provision of
fresh and purewater, toilet, washroom, elevator,
exalters etc. are installed in store
f. Information Technology Related Expenses

Retail franchisees are required to equip their stores with

information technology and carry out computerized store
operation from the day of inception.

g. Customer Relations Building Expenses

Strengthening customer relations pays off in future and
hence most retail franchisees prefer to launch customer
loyalty program.
The franchise business requires an
initial capital to finance the cost of
ARRANGIN
entry and later on some working G FUNDS
capital to finance the cost of 1. Traditional
operation in order to run the sources of Finance
franchise successfully.
2. Innovative
Broadly, these sources of finance can sources of Finance
be classified into two categories:
Traditional sources of finance
includes banks and financial
ARRANGIN
institutions. G FUNDS
Usually, a franchisor provides a great 1. Traditional
deal of support in preparing a project sources of Finance
feasibility report and provides
authentic data to justify the
marketing, technical and financial
feasibility of the franchise.
Include finance from following
sources:
ARRANGIN
a. Franchisor Sponsored Area G FUNDS
Development Programme: 2. Innovative
Basically, such programme is sources of finance
launched by a franchisor when the
franchisor is new to the market and
wants to try out its franchising
strategy implementation in a
relatively smaller area.
b. Develop and own a franchise:
Some franchisors wish their existing
ARRANGIN
stores to be operated by a team of G FUNDS
professionals to begin with. 2. Innovative
sources of finance
 MEASURIN
G
FINANCIAL
It is imperative for a
PERFORMA
franchisee to continuously
NCE
monitor the financial
performance of the franchise
business in order to assess its
viability.
 MEASURIN
It is appropriate to take a quick
G
primer at all these components:
Net Sales
FINANCIAL
It is the revenue earned by a PERFORMA
franchisee during a financial NCE
year.
Cost of Goods Sold
It is the amount paid to the
franchisor or its authorised
vendor to purchase goods for
sale.
 MEASURIN
Margin (Gross Profit)
G
The amount of net sales minus
cost of goods sold gives a figure
FINANCIAL
of margin. PERFORMA
The sales at which margin is NCE
equivalent to fixed operating cost
is called “Break-even” sales and
the point of time at which a
franchisee reaches this sales
level is called break-even point.
 MEASURIN
Operating Expenses G
All those costs a franchisee FINANCIAL
has to incur in operating a PERFORMA
franchise business. NCE
Net Profit
It is the portion of gross profit
remaining after providing for
sales related expenses,
depreciation and tax.
 MEASURIN
G
FINANCIAL
A franchisee also has PERFORMA
certain current assets to NCE
manage such as cash,
inventory, and
receivables.
 MEASURIN
Assets G
These are the items owned FINANCIAL
PERFORMA
by a franchisee that have
NCE
some monetary value.
Liabilities
These are the financial
obligations of a franchisee
that arise during the
conduct of the business.
 MEASURIN
Net worth G
FINANCIAL
The net worth of a PERFORMA
franchisee is an NCE
arithmetic difference
between total assets held
by a franchisee and total
liabilities of a franchisee.
Table
It is said that something that
cannot be measured cannot FINANCIAL
be managed. Therefore, the RATIO
performance of a franchise ANALYSIS
business should be measured
from the perspective of a
franchisee in order to enable
a franchisee to manage it
well.
1. Leverage Ratio
It measures the financial power
of a franchisee and shows a
FINANCIAL
relationship between debt and RATIO AND
equity as well as between total ANALYSIS
assets and net worth of a
franchisee.
2. Liquidity Ratio
It measures the franchisees
abilities to meet short-term
liabilities of the business.
3. Activity Ratio
It measures operational FINANCIAL
efficiency of a business. It RATIO AND
usually measures ANALYSIS
performance of fixed assets
and current assets of a firm.
4. Profitability Ratio
It measures profitability of a
franchise business.
 FINANCIAL RATIOS, FORMULA AND THEIR MEANINGS FOR A
FRANCHISEE
Profitability Ratios
RATIO HOW TO CALCULATE WHAT DOES IT MEAN TO A FRANCHISE

1. Gross Profit Sales – Cost of goods sold It indicates total margin available on sales
Margin Sales to cover operating expenses.

2. Operating Profit Profit before interest It indicates a franchisees profitability from

Margin and taxes interest the current operations before the payment
of the interest on debt and taxes on profit.
Sales
3. Net Profit Margin Net profit It indicates net profit generated out of the
Sales franchised business.

4. Return on Total Net Profit It indicates return on total investment

Assets Total Assets made by a franchised business.

5. Return on Net Net Profit It is a mathematical representation of a

Worth Total Shareholders strategic profit model for a franchisee.
Equity
 FINANCIAL RATIOS, FORMULA AND THEIR MEANINGS FOR A
FRANCHISEE
Leverage Ratios
RATIO HOW TO CALCULATE WHAT DOES IT MEAN TO A
FRANCHISE

1. Debt-Equity Total Debt It indicates the extent to

Ratio Total Equity which debt has been
financed by shareholders
equity.

2. Debt-Assets Ratio Total Debt It indicates the extent to

Total Assets which debt has been use
to finance franchise
operations.
 FINANCIAL RATIOS, FORMULA AND THEIR MEANINGS FOR A
FRANCHISEE
Liquidity Ratios
RATIO HOW TO CALCULATE WHAT DOES IT MEAN TO A
FRANCHISE

1. Current Current Assets It indicates the extent to which

Current Liabilities a franchisee is capable of
Ratio meeting current liabilities
using the current assets.

2. Acid-test Current Assets-Inventory It measures a franchisee’s

Current Liabilities abilities to meet all current
Ratio liabilities without depending
on sale of inventory.

3. Inventory to Inventory It indicates the extent to which

Working Capital Current Assets-Current a franchisee’s working capital
Liabilities has been locked in inventory.
Ratio
 FINANCIAL RATIOS, FORMULA AND THEIR MEANINGS FOR A
FRANCHISEE
Activity Ratio
RATIO HOW TO CALCULATE WHAT DOES IT MEAN TO A FRANCHISE

1. Inventory Sales It indicates the number of times the

Turnover Ratio Finished Goods finished goods inventory has turned
Inventory over a financial year.
2. Fixed Assets Sales It indicates how effectively fixed
Turnover Ratio Fixed Assets assets have been utilize by a firm.

3. Total Assets Sales It indicates how a franchising is

Turnover Ratio Total Assets utilizing all its assets (fixed and
movable).
4. Average Accounts Receivables It indicates the number of days after
Collection Period Average Daily Sales which a franchisee receives its
payments.
A franchisee would be
Net Profit Margin=Net Profit/Net Sales
primarily interested in
measuring the =770,000/15,400,000
profitability. =0.05 or 5%

The next step is to look at

asset turnover ratio. It Asset Turnover=Net Sales/Total Assets
indicates operational =15,400,000/17,040,000
efficiency of a franchise =0.89
business as total assets
include fixed assets and
current assets.
If a franchise wants to Return of Assets =Net Profit/Total Assets
measure how much =770,000/17,040,000
return on assets (ROA) =0.045 or 4.5%
is earned, following ratio
will help.

Alternately, it an be Return of Assets=(Net Profit/Net

calculated as Sales)x(Net Sales/Total Assets)
multiplication of net =0.05 x 0.89
profit margin and =0.045 or 4.5%
asset turnover ratio
It is clear form the
calculation above that
a franchisee can
improve ROA by
bringing asset Financial Leverage=Total Assets/NetWorth
turnover ratio above 1. =17,040,000/600,000
Interestingly, this =2.84
performance can be
leveraged using
financial leverage of
the franchise
business.
There is an interesting relationship between three ratios
calculated as above, which also represent efficiencies of various
managerial functions such as marketing, operations and
financial management. What if we take multiplication of these
three ratios?

Marketing x Operational x Financial

Efficiency Efficiency Efficiency
Using formula of each of the ratios, it can be written as,
=(Net Profit/Net Sales)x(Net Sales/Total Assets)x(Total
Assets/Net Worth)
=Net Profit/Net Worth
So, for Style-Wear franchise, it is 0.05x0.89x2.84= 0.1264 or
12.64%