When reviewing the Franchise Disclosure Document, most prospects’ need to carefully glean the financial statements and confirm if they are ready to partner with a Franchisor. This part of the due diligence process can often “make or break the deal.” Listed below are several important items you will want to evaluate in the Franchisor’s financials:
Step #1: Know where the financials are located in the Franchise Disclosure Document. In Item 21 of the FDD, you will want to review the franchisor’s audited financial information provided by their CPA. The trends we scrutinize include: three (3) years of the most recent audited financial statements for both the Franchisor’s income and balance statements. If three years of financials cannot be provided, request the most recent year-to-date Profit and Loss Statement.
Step #2: The balance sheet, which is a snapshot of the franchisor’s assets minus their liabilities, will conclude with the stockholder’s equity. We are looking for a 2 to 1 ratio, in relation to the amount of company assets to liabilities. In other words, we want to avoid being partnered with a business that has an inordinate amount of debt. We are also looking for the stockholder’s equity to be a 3 to 1 ratio of the company equity in relation to debt service. If these ratios are outside the parameters, we will need to confirm with the franchisor, what steps they are taking to improve their numbers.
Step #3: The income statement, which confirms the company’s profitability, should also be carefully considered. This statement compares the business income in relation to their total expenses. Typically, you will want to see that the net revenues are increasing approximately 15% yearly. Additionally, you will want to view how many dollars are collected from royalties in relation to the number of franchisees stated in Items 20. Questions such as: How much is the Franchisor spending on advertising, marketing tools, salaries and administrative expenses.
On one occasion, one of our consultants reviewed the income statement footnotes, only to conclude that the Franchisor spent more on antique cars than they did for marketing. The result: the prospect did not purchase the franchise.
Knowing and understanding these figures are an important part of the due diligence process. For more information on using a FranFinders Franchise Consultant, please call 866-288-9404 and we provide the expertise you need to purchase a franchise responsibly.
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