As a franchise coach, I get a lot of questions from people who want to become business owners. Understandably, the biggest question on the minds of prospective franchisees is, "Will I make money?"
It's worth developing a detailed answer before committing to a franchise system. Buying and running a successful business involves a lot of hard work, and business ownership isn’t much fun if you aren't making any money. While it's true that franchising is a more structured and transparent way to become an entrepreneur, it still can be complicated and confusing to navigate the process on your own.
How can you ensure your chosen franchise has the ability to make money? As always, the key is doing your due diligence.
Doing your due diligence
Before buying a franchise, it's important to learn what your experience will be like as a business owner. Those who skip this crucial step don't often remain business owners for very long because they end up with a franchise that isn't a good fit for them.
Financial viability is a key criterion for most people. If you've never run a business before, your natural instinct might be to focus on the bottom line. You're used to receiving a salary, and you want to know how much the business will be able to "pay" you. Unfortunately, it doesn't work to ask, "What is your profit?" or "What is your income?" when you're researching a potential franchise.
Looking beyond the bottom line
As a business owner, your take-home pay at day's end isn't normally a good indicator of the business' full financial benefit. In fact, many successful business owners purposely minimize their salary. Look over a franchisee's profit and loss statement (P&L), and you may notice the business appears to make very little profit -- or maybe even runs at a loss. This might seem like a huge red flag to someone who hasn't run a business. Dig a little deeper, though, and you'll notice the owner legally is allowed to list certain personal expenses as business expenses.
These owner benefits aren't reported as part of salary income. From the business owner’s family cell-phone plan to travel expenses, a wide variety of costs could be categorized as business expenses. This causes the company's bottom line to appear lower than it actually is. In some cases, an owner will pass income through a retirement account or pay dividends instead of salary.
Business ownership has a large number of tax advantages. New franchisees would be wise to seek out an experienced accountant or other professional adviser. Diane Kennedy's "Loopholes of the Rich" can be a helpful primer to learn more details before your appointment.
Taking a top-down approach
To understand a business' true earning potential, you must start at the top of the P&L.
1. List each type of income and expense. This is called a Blank P&L, and most franchisors will provide you with a copy, if you request one. Of course, you always can make some educated guesses on likely categories for both income and expense based on the type of business. As another resource, you can refer to samples of Blank P&L formats in Step 11 of "The Franchisee Workbook."
2. Examine the Franchise Disclosure Document. This document, known as an FDD, may provide additional cost information -- generally reported in Items 5, 6 or 19. The Royalty and Advertising Cost is one example. You might also find Ticket Average, Product Cost or Average Gross Sales. Insert any real figures from the FDD into your (no longer) Blank P&L.
3. Talk to franchisees. Confirm that your list of income and expenses is complete. If a franchisee mentions any expense you've forgotten, such as insurance, add it to your list.
4. Request explanations. Ask the franchisee which expenses are the largest. As a follow up, ask him or her to explain how each expense works. For example, if product cost is the largest expense, ask how much these items tend to run. You might learn that product cost accounts for 45 percent of sale, on average. Once you understand product cost, ask about other categories. One by one and franchisee by franchisee, you'll gain a greater understanding of how each income and cost category works.
5. Seek more input. Widen your net, seeking out other franchisees to help fill in any areas of the P&L that you still don’t understand. If three franchisees give three different answers for the same category, work to discover the reasons behind the variance. With this context, you can choose the answer that is most similar to the way you anticipate running your own business.
6. Do the math. Now that you have a complete P&L, you should be able to identify when the business will hit a cash flow break-even point. Determine how much volume you'll need to create your targeted income goals.
Obviously, figuring out your earning potential as a franchise owner is much more complicated than simply asking a salaried employee, "How much do you make?" But the real world doesn't offer any shortcuts. You must do the work. If you try to rush your research or skip steps, you won't understand the franchise's financial reality. Just as important, you'll never realize the business' true profit potential. A firm grasp on the numbers will enable you to make decisions confidently.
Many aspiring business owners seek help from franchise coaches, lawyers and publications. In addition to "The Franchisee Workbook" mentioned above, "The Educated Franchisee" offers useful tips.
Finding the right franchise fit is the most difficult part of franchise ownership. The rest might not come easy, but you'll feel like it's what you were meant to do -- and you'll be earning more while you do it!
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This article originally appeared on Entrepreneur.com. Minor edits have been done by the Entrepreneur.com.ph editors.