Chapter 5

FINANCIAL ASPECTS OF A FRANCHISE

Estimating Financial Requirements

Financial requirements for a franchise business may be classified into two basic categories as
given bellow:

1. Estimating Cost of Entry

2. Estimating Cost of Operation

1. Estimating Cost of Entry

A prospective franchise is required incur certain cost to enter a franchisee system. There are
two options available to enter the franchisee system discussed by previous presenters.

(a) Entering a New Franchise

(b) Entering and Site Selection

(a) Entering a New Franchise – The cost of entering new franchisee includes expense right from
start up expenses.

(a.1) Location and Site Selection – A potential franchisee has to select a specific location
and site according to the franchisor’s site selection procedure. Some franchisors offer
multiple formats and accordingly ask for different space requirements.
(a.2) Interior and Decoration – Interior and decoration plays a vital role in creating a
store layout and store ambiance. A store has to be designed in accordance with the type
of merchandise and type of customer’s service to be offered.
(a.3) Furniture and Fixtures – Some franchisees supply furniture on their own or provide
specification and a list of vendors from where the franchisees can buy a furniture.
(a.4) Licensing and Permission – It is important for a franchisee to obtain necessary
license and official permission from competent authority, in order to start the business.
Generally, license under Shops and Establishment Act is necessary to set up a shop for
retailing.
(a.5) Franchise Fee – Some franchisors charge a franchise fees for their franchisees
while signing the contract. It is, therefore, also known as contract signing amount and
usually is not refunded to the franchisees if the relationship come to an end.

(b) Entering an Existing Franchise – Cost of entering an existing franchise involves cost of
acquisition of the business of an existing franchisee. Careful examination of existing business
profit, potential, reasons why the erstwhile franchisee could not run the franchisee
successfully.
2. Estimating Cost of Operation
A franchise involves considerable amount of operating expense. A franchisee has to start from
business promotion activities to create awareness in the market. There are various other
managerial task to be carried out for the successful operation of franchise.

(i) Business Promotion Expense – A Franchisee has to begin with local advertising to
mark its presence. Some franchiser requires that the franchise must be done with the
bang.
(ii) Training and Development Expenses – Franchisees are expected to train people as
per 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.
(iii) Inventory and Warehousing Expenses – A 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.
(iv) Employee related Expenses – Employee related expenses include wages and salary,
insurance and other allowances to be paid to the employees. Moreover, it also includes
expenses to be incurred for the uniform, name plate, and identity card as well as other
record keeping.
(v) Amenities Realated Expenses – In order to create comfortable shopping
environment, certain amenities such as air conditioning, provision of fresh and pure
water, toilet, washroom, elevator, exalters etc. are installed in store. Some retail
franchisees even maintain waiting rooms for shoppers.
(vi) IT Related Expenses – Retail franchisees are required to equip their stores with
information technology and carry out computerized store operation from the day of
inception.
(vii) CRM Related Expenses – Strengthening customer relations pays off in future and
hence most retail franchisees prefer to launch customer loyalty program.

Arranging Funds
The franchise business requires an initial capital to finance the cost of entry and later on some
working capital to finance the cost of operation in order to run the franchise successfully. A
franchisee has to explore various sources of finance in order to set up the business. Broadly,
these sources of finance can be classified into two categories:

1. Traditional sources of Finance

2. Innovative sources of Finance

1. Traditional Sources of Finance

Traditional sources of finance include banks and financial institutions. Banks and financial
institutions provide finance based on their appraisal of the project feasibility report submitted
by the prospective franchisee.
2. Innovative Sources of Finance
Innovative sources of finance include finance from following sources:

(a) Franchisor Sponsored Area Development Programme:

Basically, such programme is 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. The
expenses of site and location development, business promotion, and store operations are fully
sponsored by the franchisor.

(b) Develop and Own a Franchise:

Some franchisors wish their existing stores to be operated by a team of professionals to begin
with. The franchisors invite professionals to operate existing stores at various locations on a
lease basis.

Measuring Financial Performance:

It is imperative for a franchisee to continuously monitor the financial performance of the
franchise business in order to assess its viability. Some of the components of profit and loss
account such as net sales, cost of goods sold, margin (also known as gross profit), operating
expenses and net profit. It is appropriate to take a quick primer at all these components:

Net Sales – It is the revenue earned by a franchisee during a financial year. An amount
of net sales is derived after deducting cash discounts, employee discounts, markdowns
and free samples.
Cost of Goods Sold – It is the amount paid to the franchisor or its authorized vendor to
purchase goods or sale. Freight charges and other taxes are added while trade discount
obtained on purchase is deducted in order to arrive at this figure.
Margin (Gross Profit) – The amount of net sales minus cost of goods sold gives a figure
of margin. This is an important component of financial analysis. The amount of margin
should be capable of covering the operating expenses and should leave sufficient scope
for making net profit.
Operating Expenses – All those costs a franchisee has to incur in operating a franchise
business. A detailed list and description of these cost heads is given in by the previous
chapter before.
Net Profit – It is the portion of gross profit remaining after providing for sales related
expenses, depreciation and tax.
Assets – These are the items owned by a franchisee that have some monetary value. As
evident from the list above, the major asset a franchisee owns is the store/property.
Liabilities – These are the financial obligations of a franchisee that arise during the
conduct of the business. Major liability of a franchise is the long-term loan obtained
from the bank/financial institution or sometimes from the franchisor.
Net Worth – The Net Worth of a franchisee is an arithmetic difference between total
assets held by a franchisee and total liabilities of a franchisee. It is also known as
 owner’s equity and indicates the value of a business after providing for all the financial
obligations.

Financial Ratio Analysis

It is said that something that cannot be measured cannot be managed. Therefore, the
performance of a franchise 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

relationship between debt and equity as well as between total assets and net worth of a
franchisee.
2. Liquidity Ratio – It measures the franchisee’s abilities to meet short-term liabilities of
the business. Ideally, a current ratio of 2:1 indicates healthy financial position of the
firms and indicates that the franchise business is liquid.
3. Activity Ratio – it measures operational efficiency of a business. It usually measures
performance of fixed assets and current assets of a firm/
4. Profitability Ratio – It measures profitability of a franchise business. Favourable
profitability ratios indicate how efficient a franchisee is in term of sales and marketing
management.

Bugante, Tiffanie L.
David, Margie L.
Lucero, Mary Grace R.
Quinto, John Erwin A.
Tigson, Kristine Kaye M.