Franchise Financial Expectations
1. Financial prudence pays rich dividends
If you are like most typical franchisees, you will have invested your life-savings into your business and taken on a heavy debt load as well. Moreover, you are probably working harder than you have ever worked before in your life, so who could blame you if you are calling for payback time. This is understandable but perhaps a little premature. Many promising start-ups have failed because of owners making excessive drawings, so our advice is to give it time. This article will guide you.
2. What the business should be paying you
On the face of it, you have it made. You are entitled to draw a market-related salary and whatever profits the business makes are yours to keep, right? Well, yes but there are a few things you need to consider.
On paper, you have indeed the unfettered right to write your own salary cheque and any profits the business makes are yours to keep. Sounds great but the harsh reality is somewhat different. You need to remember that in a business, whatever amount of money you want to draw out of it needs to come in first.
3. Third-party payments come first
This is where individuals who used to work for large corporates in the past tend to come unstuck. In addition to a fat salary, they were used to enjoying a series of executive perks which a new small business may not be able to afford. In this context, you need to remember that cash flow doesn’t equal profit. Any money that comes in must be used to pay running expenses, suppliers’ bills, reduce the overdraft and make the monthly repayment on the bank loan. Only after all these payments have been made is it your turn. Even then, prudence is advised. Small business guru Eric Parker has coined the terms “cash absorbers” and “cash generators”.
Cash absorbers are items that gobble up lots of cash without producing commensurate returns. Examples are fancy motorcars and unnecessary travel expenses. For the first few years after start-up, it is best to avoid those.
Cash generators are investments that offer regular above-average returns plus a capital gain when you divest. Investing money into your own business can be an excellent cash generator.
4. The need for a financial cushion
In most industry sectors, business tends to fluctuate throughout the year. Partly, this can be linked to seasons and entrepreneurs can provide for it, but unplanned hiccups can also occur. The recent economic crisis which affected the whole world is a case in point. Should cash flow be chronically tight and such an event occurs, it could mean the end of your business. That’s why it is advisable to set aside some money each month to build up an emergency fund.
In most instances, yet another fund is needed. From the second year of operations onwards, you should start setting aside money for a business revamp. As the business grows, it may become necessary to invest in extra equipment. And at the end of the period for which the franchise is initially granted, usually 5-7 years, renewal of the franchise agreement will probably be conditional on a revamp.
Granted, the loan you took out when you started the business will be paid off by then but instead of taking out another loan for the full costs of the refurbishment, you should accumulate at least part in cash. Most banks will require a cash contribution to extend further loans to an existing business. Do the sums and you will agree that a better investment would be hard to find.
5. So where is the pot of gold, then?
Fair question – and we can respond with good news at last. Entrepreneurs who apply financial prudence during the early years after starting a new franchise are getting closer to it every day. Unlike an employee who depends on management’s discretion for pay increases, entrepreneurs can adjust their drawings in line with business performance. Come financial year-end, they can top this up with a handsome dividend (but not before an allocation has been made to the Business Improvement Fund). And the best is yet to come.
The real wealth generator
Every industry sector insider will tell you that when one takes monthly drawings and annual dividend payouts into account, franchisees who have chosen their brand correctly and follow the proven blueprint to the letter enjoy higher earnings than individuals who depend on a salary, but there is more. The real benefit comes when it’s time to cash in the chips. Come retirement, employees are typically seen off with a golden watch. An entrepreneur, on the other hand, owns a business with a profitable track record that can either be passed on to heirs or sold at a substantial capital gain. All this leads us to conclude that when you want to make real money without having to operate in isolation, becoming a franchisee is the way to go.