Ten common financial mistakes made by Franchisees
Article by Chris Roberts
The Consultants at Franchise Finance arrange funding and prepare business plans for prospective and existing franchisees on a daily basis. They also undertake Business Healthchecks for existing franchisees.
As a result of these activities Chris Roberts QFP, Director of their Business Training Academy has drawn up a list of the "Ten most common financial mistakes made by franchisees" and here it is:
1) Not borrowing at the outset and using up all or most of your own money first
It is not uncommon for people, with just enough cash, to use their own money and not borrow because they don't want to pay fees and interest or because they don't think the banks are lending. This can be a very bad decision because in these somewhat uncertain times, it is possible that trading may not be as good as was originally expected and therefore you could start making losses and running out of money. An approach to a bank at that stage, where losses are being made and the business performance is behind plan, will almost certainly be unsuccessful and the business could easily fail because of a lack of cash.
In reality, it would be much better to request a loan at the outset, say for 50% of the total amount required, when everything looks 'rosy' and the business plan demonstrates viability because the problem has not yet occurred. Therefore, when and if the problem does occur you have your own cash 'safety net' which you can use to get you through your 'sticky patch'.
Alternatively things may be going really well for you and you decide you want to expand.
Perhaps buy a second territory or another outlet. So because you don't have any spare cash you decide to approach your bank. Our experience, particularly in the current economic environment, is that banks will require you to put in some further new money at that time, being often not willing to solely rely upon what you put in as your contribution at the outset. So, once again, it would have been better to have borrowed at the beginning and kept some of your own money back to assist your expansion plans when you (and not the bank) felt the time is right.
2) Not having a business plan to help quantify business and financial objectives
Starting or growing a new franchise business without a comprehensive and professional Business Plan is rather like going on an important car journey without a road map, not knowing how safe your car is and how much petrol you have or will need to reach your destination!
Do you really want to leave so much to chance or do you want to give yourself the best possible opportunity to arrive safely, or in the case of your business, make sure that you achieve your key business objectives without running out of money?
This is why having a good business plan, whether you are borrowing money or not, is so important. It acts like your Business Sat Nav, helping to guide you from where you are now to where you want to get to on your business journey. Helping you to see what is around the corner and giving you something to regularly measure your actual progress against.
3) Not having a full set of financial projections to ensure the business has sufficient working capital
Make and see your mistakes ‘on screen’, not in real life! You should use a projected profit and loss account to gauge profitability and ensure your plans are worthwhile taking forward and a cashflow forecast to establish how much money you need at the outset so you do not run out of working capital during the course of your journey. It is so important to be absolutely sure that your business is properly capitalised at the outset.
The reality is that sales in the first few months are likely to be lower than the last few months of the year because it is likely to take some time for the business to become established. However the overheads (e.g. salaries and rent etc.) will probably be consistently high from the first month. This means that for the first part of the year the business will be making a loss and will need some additional cash to sustain it through and into the profitable months in the second part of the year. This additional cash is what we refer to as ‘Working Capital’.
The same problem arises if an existing business is suddenly going to increase its planned sales, perhaps because of a new marketing strategy or a new product launch. To cope with the extra expense and probable time lag, before sufficient cash from sales is received, the business is likely to require additional working capital. The question of how much will be answered by using the projections model described above.
4) Not monitoring actual performance against the projections or using sensible KPIs (key performance indicators)
In the same way as with a car journey you need to check from time to time that you are on track to arrive safely at your destination, as planned. It is exactly the same with your business journey so you need to monitor your actual performance against your financial projections using appropriate KPIs.
5) Not taking any training courses to give yourself sufficient financial knowledge to ensure you actually understand what is happening within the business
When you first drove a car did you just leap in and drive off, or did you have some driving lessons? The same applies to your business journey so don’t make the mistake of setting off (or carrying on) if you don’t really understand business finance and accounts.
You need to be able to ‘read’ and use a profit and loss account and balance sheet to help you make informed and sensible decisions. You need to know how and which accounting ratios and trends to focus on so that you can spot potential problems and take appropriate actions before they become real problems!
6) Not knowing what you don’t know!
It used to be impossible to know ‘what you don’t know’. Thankfully this is no longer the case so don’t allow yourself to think you know ‘all you need to know’ just in case you don’t!
Instead you can take the Franchise Finance ‘Financial Awareness Assessment’ which will help you to decide whether you need any particular financial training. This takes about half an hour, can be accessed at home on your own computer and costs £25 + VAT.
Participants are asked to answer a series of multiple choice questions and undertake some basic calculations centred on a Balance Sheet, Profit and Loss Account and some financial projections. A mark out of 100 is awarded. A score of less than 50 indicates that the participant needs to increase their knowledge and would definitely benefit from one of our courses or workshops and a score of between 50 to 80 means they have done quite well but may still benefit from one of our more advanced training programmes.
7) Not understanding the difference between ‘Profit’ and ‘Cash’
People like talking about ‘Profits’. How much they are going to make or how much they have already made! Yes this is hugely important because you don’t want to be running a loss making business. However, what is even more important is the answer to the question ‘Do you have enough cash to pay your bills, as and when they become due’?
Let’s assume a franchise supplies goods on 30 days credit and on a Friday afternoon they make a £20,000 sale for goods they bought for £10,000. They despatch the goods and raise an invoice. Therefore they can legitimately claim to have made a ‘profit’, and they may therefore decide to celebrate that weekend with several bottles of wine! However, if they come back into work on the Monday morning and need to pay the VAT bill or perhaps the wages and they don’t have enough cash in the bank to do so, they are in big trouble. Yes they have made a ‘profit’ but it is having a sufficient amount of cash, or working capital that really matters. So remember :
TURNOVER IS VANITY **** PROFIT IS SANITY **** CASH IS REALITY !!
8) Not using ‘Asset Finance’ (e.g. Leasing) and thereby using up valuable bank borrowing opportunities that may ultimately be needed for working capital purposes
Asset finance is a type of finance used by businesses to obtain the equipment and vehicles they need to grow. It usually involves paying a regular charge for use of the asset over an agreed period of time, thus avoiding the full cost of buying outright. The most common types of asset finance are leasing and hire purchase. There are some straightforward reasons why you might decide to use this form of finance such as lower contribution levels, and the fact that the security is the asset itself rather than there being a requirement for personal security, but an often overlooked reason is that if you use a bank loan to buy these types of assets you are using up a finite amount of credit that your bank is likely to give you. You may well need this as ‘working capital’ and it could be unwise to use up your ‘available credit’ unnecessarily.
9) Not having a good and suitable accountant as part of you ‘extended team’
Your accountant should understand you and your business model. Please ensure you share your personal and your business goals so that you are both 'singing off the same hymn sheet'. For example, do you want to show low profits because you want to minimise tax or do you want to show high profits because you want to impress your bank manager so you can borrow more money to grow? If your accountant doesn't show an interest and 'buy in' to your business goals and strategy then it would be better to move on and find one who does.
Indeed your accountant needs to understand the whole picture and be more than a financial record keeper. They should know or acquire some industry related knowledge (i.e. of franchising and your own industry sector) and don't just wait until you get your year-end accounts to undertake joint reviews otherwise it could be too late! Hold regular reviews together perhaps examining management accounts on a quarterly basis. Finally, ensure you know how much the service you want is going to cost you. Consider whether it would be better for you to pay for this monthly or at the end of the financial year and negotiate accordingly. Also don’t be afraid to ask for a service level agreement.
10) Not preparing for eventual exit so the value of the business and sale proceeds are not maximised
When it comes to eventually selling your business there is a lot you can do in advance to ensure an easier and quicker sale. Failure to prepare can affect your ability to sell, it can affect the price you achieve and can also affect the ability of the potential buyer to raise the finance they may need.
You need to ensure that when a purchaser undertakes their due diligence you will have reduced the risk of them finding any major problems so getting into good habits right at the beginning makes good sense as does undertaking mini annual ‘Health checks’ or MOT’s as though you were an outsider, ‘looking in’!
It also makes sense to use the services of a professional consultant at least two years before you propose selling the business to help you ‘shape’ the last few years, show appropriate trends and begin to create the ‘sales pack’ to maximise the ‘good will’ value you will hope to receive.
The author of this article, Chris Roberts, is a Director of Franchise Finance Limited and a British Franchise Association Qualified Franchise Professional. To contact Chris and to find out more about the services Franchise Finance offer, click here
Last Updated: 19-February-2016