Buying a franchise may be something that you have always wanted to make happen, and you are not alone. There are over three-quarters of a million franchises operating in the US today.
There are some real pluses to buying a franchise, and the biggest one is that the business model already exists, which helps new franchisees focus more on growing the business versus starting it from scratch.
On the downside, franchises have special accounting needs that are much different than other small businesses. As a business owner, you may know how you are going to increase sales, but you may not know how to manage complicated and deadline-oriented franchise accounting.
The good news is that an accountant who specializes in franchises can help you manage the many deadlines, franchise fees, payments, contract renewals, and ongoing costs.
Before Signing a Franchise Contract
Before you sign on the dotted line and purchase a franchise, you need to know how to read the franchisor’s financial statements. This will help you determine the financial health of the business. An accountant can help you review the statements and explain them in detail, and ultimately help you avoid making a poor decision.
An accountant will identify whether the franchisor shows steady growth, has a growth plan in place, has solid income from successful existing franchisees, and whether they devote sufficient funds to support their franchise system.
Right out of the starting gate, franchise accounting is unique compared to the start-up fees, costs, and deadlines of other small businesses.
Here are the basics of franchise accounting:
The franchisor owns all the franchise locations. They manage the brand. The franchisor decides which products and services are sold. They also own the rights, trademarks, and licenses to the brand, product, or business.
The franchisee owns an individual franchise location. They operate the franchise under the guidelines set by the franchisor through a contractual agreement.
Payment of the franchise fee, royalty fees, additional fees in some cases, and renewal of the franchise contract, allows the franchisee to continue operating the business within the protected territory (that other franchisees cannot encroach).
Initial Franchise Fees and Expenses
The initial franchise fee is typically paid to the franchisor. Start-up fees run in the range of tens of thousands of dollars to several hundred thousand dollars and may be non-refundable.
The franchisor’s start-up package may include the basic business license, training, equipment, location search, assistance with opening, and signage. Some start-ups include a full turn-key package, including most everything that is required to open the doors on the site.
Some of the Initial expenses that might not be covered by franchise fees may include rent, building equipment, operating licenses, insurance, and the purchase of initial inventory.
After a franchisee begins doing business, he or she must pay a portion of the revenue to the franchisor. These are called royalty fees.
The payment schedule for royalty fees varies between franchisors, but some are paid every week, and some are authorized through an agreement to deduct directly from the franchisee’s checking account.
Royalty fees are required even if the business is not making a profit, and a franchisee may have to continue making royalty payments even if they terminate the franchise agreement.
Marketing and Advertising Fees
Some franchisors charge advertising and marketing fees. The franchisee’s payment of fees contributes to a fund that pays for advertising materials and marketing costs. These fees are typically a small percentage of gross sales.
Renewals and Terminations
Contracts are always stringent pieces of a business, but with a franchise, the right to continue the business can be easily pulled if the franchisee has not followed the specific requirements of the agreement. Franchisors can terminate the agreement for many reasons, including failure to pay royalties, making late payments, or failure to sign a renewed franchise agreement.
Franchisors may opt to raise royalty payments, impose new standards and restrictions, reduce territory, or make other changes that result in higher costs and reduced profits for the franchisee instead of ending the contract.
Franchise agreements can run for any number of years, typically between 5 and 20 years but they are not automatic. A franchise agreement can expire – renewals are time-sensitive transactions. A franchisee’s entire business investment can be lost simply by missing the deadline.
Amortization of Franchise Fees
The franchisee can deduct initial franchise fees from their business tax return, but the franchisee must amortize the fee. This means that the cost of the fee is spread out over a specific number of years, but not beyond the length of the contract.
All businesses experience ongoing costs, and some of these expenses come with additional deadlines.
Ongoing costs may include:
- Business and operating licenses (renewal deadlines)
- Products and supplies
- Building and land improvements
- Equipment repair and maintenance
- Equipment purchases
- Business insurance (renewal deadlines)
- State and local taxes (filing deadlines)
- Employee salaries
Franchise accountants not only track costs but also track associated deadlines to cover the expenses, including fees and document agreements.
Budgeting is important to cash flow, and a franchise accountant will review current expenses and fees, and ongoing debt, and will know the requirements to cover future events and avoid monetary shortfalls.
Many businesses fail in their youth. Some do not break even for several years. A franchise accountant will compare costs with other franchises in the industry and will recommend budgets and strategies to help the business not only survive but grow.
We Can Help with Your Franchise Accounting
Whether you are considering the purchase of a franchise, or are running one, we can help you make sound financial decisions and assist you with your franchise accounting needs.
Our 16 years of experience in the accounting and tax industry includes a wealth of franchisee knowledge.
We offer a range of franchise services. We will not only help you meet your intense deadlines, but our general accounting, financial statement preparation, and franchise tax knowledge will guide you and your business to the next level.
Are you ready to get started?
Schedule an intro meeting today.