5 minute read
Kate Groom
fIve key questIons for your fInancIal due dIlIgence
Kate Groom is co-founder and director of Franchise Accounting and Tax. She has previously worked for franchisors and as a business adviser. Kate’s focus is on helping clients understand the financial aspects of running a business and on business planning and coaching. She is also a director of a number of ‘not for profits’. https://www.franchiseaccountingandtax.com.au/
Financial due diligence is the process of investigating the financial potential of the franchise you’re interested in and understanding the financial risks.
It’s a good idea to get advice from an expert franchise accountant, however it’s also important to know what questions to ask. In this article we’ll highlight some of the important questions a franchise buyer should consider as part of their financial due diligence. No matter how much you love the idea of owning a business, it’s important to assess the financial potential of the franchise. The financial due diligence stage of buying a franchise is where you work out what it will cost to buy the franchise and operate the business. Once you know the costs, you can work out your sales target and assess whether it’s achievable. Good financial due diligence helps reduce the risk of investing your money in a business that can’t deliver the financial results you need. Before you start your financial due diligence you’ll need to obtain some information from the franchisor. You’ll find this information in the Franchise Disclosure Document. Some franchises also provide financial information in the form of a spreadsheet. For financial due diligence, you’ll be looking at the sections that show the costs to set up and operate the franchise, and any information about the financial results of existing franchisees, such as sales and costs. If you’re buying an existing business you will also have the financial results of that business, which you will obtain from the business owner or their broker. It’s important to understand that most franchises don’t provide projections or forecasts of financial results. It will be up to you and your franchise accountant to create financial projections based on the information you have received and your understanding of the business. To help you in your financial due diligence, here are five key questions every franchise buyer should consider.
1. What are the set-up costs?
When you buy a franchise you will need to finance the setup costs for the business. It’s important to understand what these costs are, as you’ll need to be able to cover them either with your own funds or by borrowing from a bank or finance company.
In most franchises the set up costs include the following broad categories:
• Initial franchise fee • Training fees, including travel and accommodation
• Initial marketing fees, for instance to cover local marketing during your first few weeks in business
• Fitout of the business premises, or purchase of a vehicle for a mobile business
• Equipment necessary to operate the business
In addition, you’ll need to cover the costs of legal and accounting advice, set up of your trading structure, and the deposit on a lease if you operate from a physical location. You’ll also need to purchase any necessary opening stock or inventory items.
It’s vital that you understand the ongoing costs to operate the business. Without this number it will be impossible to work out your sales target and assess whether the business is likely to be financially viable. You will find estimates of some operating costs in the disclosure document. Some franchisors provide a lot of helpful detail, others are less clear — which will mean you’ll need to do more research of your own. It’s a great help if the franchisor provides historical information based on the results of existing franchisees. Although every business is different, the main cost categories are: • Stock for sale, raw materials, and so on (often referred to as ‘Cost of Goods Sold’)
• Royalty and other fees paid to the franchisor
• Rent for your shop or office • Wages and Superannuation for employees • Insurance and workers compensation • Accounting and tax advice • Advertising and marketing • Office expenses, including IT and technology costs • Training and conferences • Motor vehicle expenses • Repairs and maintenance It’s also important to know what your loan repayments will be, whether this is to a bank or repayment of your own funds invested in the business.
3. how much do you need to make?
To properly assess the franchise you need to build your own wages and superannuation into the costs of operating the business. If the business can’t pay you an appropriate wage for the work you do, then no matter how much you love the concept you’ll eventually become frustrated. So it’s a good idea to think about how much you need to cover your basic cost of living, what a reasonable wage is for the work you do, and how much you would like to make in a year or two’s time.
4. What is the sales target?
Once you know the costs to operate the business, including your wages and any loan repayments, you can work out the sales revenue that’s needed to cover these costs. You might also want to break this down into the number of customers and the average amount they spend. The next question is a very important one. Once you know the target sales level, the question becomes “How confident are you that you can achieve this target and keep the number growing to cover cost increases over the years?” To answer this question you’ll need to talk to existing franchisees and the franchisor. Find out what sales the franchisees are achieving, and what the franchisor will do to help you achieve this target.
5. how long will it take to reach break-even?
Break-even is the point at which the sales revenue of the business is sufficient to cover the costs of operation, loan payments and your wages.You’ll need enough money to cover the costs of operation and your living costs until the business is trading above the breakeven each month. Your franchise accountant can help you work this out by preparing a financial forecast and cashflow projection. These five questions will help you develop an understanding of the costs to set up and operate the franchise. The answers will help you assess whether you can afford to buy the business, and whether it can provide you with enough money to live on. While it might seem like a lot of work, the effort is worthwhile as it will increase your chances of success and reduce the risk that you’ll buy into a business that’s not financially viable. v
