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Franchising - taking a closer look at the numbers print Print

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This article seeks to help you answer two basic questions: What can I afford and how much money will I make? Below, we take you through a simple step-by-step process to help answer these questions.

Step 1. How much do you have available to invest in a franchise business?

For many New Zealanders, equity (assets less liabilities) is often tied up in a house. So, you need to understand how much of that equity can be freed up to invest in a business. Most banks, depending on their lending criteria, may be prepared to finance up to 80% of the value of your house for personal and/or business purposes.

A simple example is shown below:

House value: $500,000

Mortgage: $320,000

Equity available:

$500,000 x 80% = $400,000

Less mortgage = $320,000

Net equity $80,000

If you have additional savings, these should be added to the equity available.    


Step 2: How much can you borrow against the business?

Depending on the franchise system, banks may lend up to 60% of the cost of the business. You should speak to your bank to establish how much they might lend against a particular franchise.

A simple example is shown below:

Ingoing cost of franchise business: $200,000*

Amount bank will lend: 60% = $120,000

* The ingoing cost of the business may also include an allowance for working capital if it is not already calculated as part of the purchase price.


Step 3: How much income do I need from the business?

The easiest way to determine the personal income you require from the business is to write down your planned personal expenditure for the next 12 months (including living expenses, savings and mortgage repayments) and subtract this from any other sources of income such as share dividends, rent, spouse's wages. The shortfall will be the amount you require from the business. Don't forget to budget for additional mortgage repayments if you are planning on increasing the borrowing against your house.

A simple example is shown here:

Spouse's wages $35,000  
Board $5,000  
Total $40,000  
Food $8,000  
Utilities $3,000  
Education $6,000  
Holidays $10,000  
House repairs $10,000  
Insurances $4,000  
Other living expenses $3,000  
Mortgage repayments $20,000  
Savings $8,000
Miscellaneous $1,500  
Total $73,500
After tax income required $33,500  
Before tax income required $50,000*

* For the purposes of this example we have used a flat tax rate of 33%.

The above list is sometimes called an Income/Outgoings Position. 

We have assumed in this example that $50,000 is a fair salary for the time and effort required to run the business (a good check is: if you had to pay someone else to manage your business for you, what would a fair wage be?).


Step 4: What is a reasonable return on investment (ROI)?

Making enough money to live is an important consideration, but not the only one. Presumably, if that was your only consideration, you could remain an employee of someone else and not put any of your own money at risk. So you need to be comfortable that the return you are likely to make from your investment is adequate to cover the risk involved.

To work out a reasonable rate of return, you should take the base rate you could receive if you invested your money in the bank and add a margin for the level of risk associated with your particular business. A simple example is shown below:

  • Low-risk investment base rate: 7%*
  • Margin for retailing business risk: 18%*
  • Desired return on investment: 25%

Note: These are not fixed figures and are used solely for the purpose of this illustration. The investment base rate changes regularly and the specific risk associated with your business will depend on many factors. You should speak to your investment adviser or accountant to establish a reasonable rate of return for your particular business.

Using this example, if you were to purchase a business for $200,000, you would expect an annual profit of $50,000 ($200,000 x 25%). This is after taking out the proprietor's salary but before factoring in interest repayments or tax and is often referred to as EBIT (earnings before interest and tax).

You may also see the term EBIPT, which is earnings before interest, proprietor's salary, and tax. In other words, the sum total of the owner's salary and profit.

Bringing the examples used in Steps 1-4 together, you can afford to invest $80,000 of your own equity and borrow a further $120,000 to purchase a franchise business for $200,000. From that business you are expecting to draw a salary of $50,000 and to make a profit of $50,000 on top of that.


Step 5: Does the franchise opportunity meet your financial criteria?

Assuming that you have made some initial assessment of the type of franchise you want to buy, you can now concentrate on evaluating the franchise from a purely financial point of view.

Firstly, you need to get the information necessary to make your calculations. The franchisor will not usually provide you with profit projections for your particular franchise, but what they will usually do is provide you with either:

  • Actual profit figures of some other franchises in the group, or
  • An estimated profit margin for your franchise (which is based on the performance of other franchises in the group).

If the franchisor is prepared to give you actual profit statements from some existing franchises, you should be looking for operations similar to the one you are considering. There can be significant variations between franchises and some major variables are:

  • Rent - this is probably the greatest variable between retail stores in particular. A franchise business inAucklandis probably not a fair comparison with a store in Nelson
  • Customer base - if location is a key factor for the particular business, look for businesses in neighbourhoods with similar demographics
  • Store type - look for stores of a similar size, in a similar type of location (e.g. shopping mall vs stand-alone shop) and with similar parking
  • Experience of franchisee - a well established business may have an established customer base and more efficient systems than someone in their first months of operation. Don't expect that you will achieve the same profit levels as an experienced operator straight away.

If the franchisor is not prepared to show you actual profit statements from existing franchises, the next best thing is to analyse the projected ratios they give you. Sometimes they may just provide ratios based on turnover (e.g. staff costs 20% of turnover, net profit 35% of turnover ) but often they will also provide some scenarios based on different turnover (sales) levels. It is important that you and your accountant work through some scenarios yourself and accurately estimate all of your costs.


Summary: Weighing it all up

Following the steps above should allow you to work out whether a franchise stacks up financially - but please note: the examples worked through here are fictional and should not be relied upon as actual guides. It is also important to note that, as with buying a house, buying a franchise is not purely a financial decision and there may be a number of factors, other than how much money you will make, that enter into it.

As the information provided above is purely an outline guide, it is recommended that you prepare a short business plan, a projected profit and loss statement and a cash flow forecast for your business in order to estimate its actual activity more accurately. For help with preparing any of these, refer to the ANZ Business Planning CD.


Further information:

To talk to an ANZ Business Specialist:
Call 0800 269 249
Visit your nearest ANZ branch


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