DOING THE SUMS
ON BUYING A FRANCHISE
in this article:
October 2010 - How do you evaluate a franchise from a financial point of view? Lorraine Lord follows one man’s journey as he does his sums on a real-life business opportunity
Buying a business is a big decision. Elsewhere on this website you’ll find plenty of advice on what to look for in a business and how to find a franchise that suits your own needs, but in this article we focus on the money. To make it easy to understand, we asked Fastway Couriers, one of New Zealand’s most respected and award-winning franchises, to take us through the figures supplied to a real-life buyer so that we could follow his journey as he decided whether or not to take up a franchise.
To protect the purchaser’s privacy, we won’t identify him or the area concerned and we have changed some details. We should also point out at the start that while the figures below were real for this one particular business at the time of writing, they are not a guarantee that all Fastway courier franchises would show the same results. Note also that some details or fees may have changed since this article was written in 2010, and may not reflect current practice within this particular franchise. We’re just using these as an example to help you work out how to evaluate any franchise that you might be interested in – whatever the type of business.
John liked the idea of working for himself and had become interested in becoming a courier franchisee with Fastway. Fastway Couriers is a New Zealand company that operates in nine countries. The company operates nationally via a network of Regional Franchisees, each of whom operates a central freight handling depot. They then grant, train and support individual courier franchisees who actually collect and deliver the parcels and freight.
John was attracted by the fact that it was a five-day-a-week business that would get him out and about, rather than being stuck in the same place. He thought he had enough money to get started and had already had an initial interview with his local Regional Franchisee. Let’s pick up John’s story here.
Having talked to the Regional Franchisor and read the information he was given, John decided he wanted to find out more. He filled in an application form and signed an agreement that stated that he would not discuss the confidential information he received with anyone other than his professional advisors (a lawyer and accountant). He was then given a Disclosure Document that contained some detailed information about the franchise, how it worked and what sort of fees were involved. The Disclosure Document was also very clear about the need for him to take professional advice. It said, ‘It is compulsory to obtain legal advice before entering into a Courier Franchise Deed... We also advise you to obtain accounting advice before commencing.’ It also pointed out that advisors would charge for their services and suggested, ‘Ask your lawyer and accountant for a written quote before they commence any work for you. This way you should not receive any unexpected costs. Courier franchisees have said in the past that legal fees generally vary between $500-1000, but this depends on the amount of work required, and an individual’s unique requirements. If a courier franchisee incorporates a company, the fee is approximately $950.’
The Disclosure Document showed example figures for a new courier franchise, pointing out that these may vary for any individual franchise. In John’s case, though, he had found out that there was an existing courier franchise for sale which offered an exclusive territory close to his home. Because it was already operating, the franchise had existing customers and he was able to see actual financial information for that business. This made it easier for him to work out how much capital he needed to invest and to get an idea of how much money he might make from it. In the following, we have rounded figures supplied to the nearest dollar.
The first thing John had to consider was the cost of setting up his new business. First, he needed to cover the $30,000 purchase price of the existing franchise. As it was an existing business (ie. a ‘going concern’), there would be no GST to pay on this. He could also buy the franchisee’s relatively new vehicle for $15,000 (he could alternatively lease one, although having it sign-written would cost an additional $712) and uniforms to last the first year. John listed all these items and amounts as shown in Table 1 and found the total cost was $45,260.
In addition to these, there were several additional items that would be supplied by Fastway. Rather than paying for these upfront, Fastway would deduct the cost from his first month’s remuneration as a franchisee: these included business stationery, a fuel card and the bond for his security ID card. He noted that a cellphone was supplied at no cost under a special deal Fastway has negotiated with Telecom. These items totalled a further $321.
He also had to allow for other admin and set-up fees. Having talked to a lawyer and accountant as well as the franchisor, he allowed a total of $2,000 for this.
John now knew it would cost him around $48,000 to set up his business. The next stage was to work out how much it would cost him to run it – the ongoing costs. John was given these costs in two categories: fixed costs and variable costs. He listed them in Table 2.
The fixed costs are the items he would have to pay for whether he got into his van each day or not: things like the portable barcode scanner that cuts out so much paperwork and streamlines the whole Fastway system; carrier, vehicle and liability insurances; vehicle registration; and the loading fees that contribute to the costs of the regional freight centre. Some of these are calculated weekly, some monthly or annually, but John calculated they would cost $3412 per year, with an additional amount of around $1100 being needed for the recommended personal accident and illness insurance.
The variable costs are the costs incurred once John got on the road and started doing business. They include fuel and all the vehicle servicing costs, phone calls, marketing material and, after the first year, replacement uniforms. Many of these costs show the benefit of group buying discounts. The figures estimated the total variable costs for the year at $8288, meaning that the fixed and variable costs would come to $12,800.
Fastway is a little different from some franchises in that much of the day-to-day administration work is done for courier franchisees by their Regional Franchisee. Each courier franchisee receives a weekly remuneration report that shows his income minus expenses. John thought this was really convenient and would save him a lot of time and trouble.
He did, however, have to allow for a time lag in receiving his first month’s money from Fastway. Remuneration is paid to franchisees one month in arrears on the 28th of the month following, so he needed to be sure he had adequate capital to live on and run the business for almost two months before receiving his first monthly payment from the franchisor.
Fastway Couriers offers customers a simple system where they pre-buy books of labels for sticking on to parcels, with different coloured labels each representing a different price. The further the parcel has to go, the bigger the price label. Each label is scanned both by the courier franchisee who picks it up from the sender, and by the one who delivers it to the recipient. Franchisees earn remuneration in three ways:
1. Collecting parcels for delivery.
2. Delivering parcels.
3. Selling books of labels to their customers at 10% commission.
Each week, the franchisee receives a report showing their income in each of these areas plus any allowances or adjustments. The report also shows deductions for services provided by the franchise such as the scanner and loading fees (as shown in Table 2). Payment is made either by cheque or direct to the franchisee’s bank account. John liked the simplicity of this system and the accountant he used was impressed by the detail of the reporting and the transparency of the information. The reports even show daily sales by label type, which makes analysis of the sales data simple.
John was now able to transfer all the information he had gathered so far into a new table (Table 3) that would form the basis of what is called a Profit & Loss Account. This showed his income from Fastway for the year. He then deducted the annual totals from the Fixed Costs and Variable Costs tables to show his potential operating profit for the year.
Looking at this table, John could see that the key to growing a successful business is sales. Fixed costs do not increase when sales go up, so he would therefore achieve better margins on every sale he made. Variable costs would go up but only in proportion to the increased sales, so the more sales he made the greater his operating profit would be.
Fastway explained to John that, as courier franchisees cannot control the level of deliveries received for their territory, they are encouraged to seek new pick-up business. This earns them both commission on label sales and redemption income each time they pick up a parcel. To help franchisees find new business there are marketing programmes and material to use when delivering a parcel which help convert potential customers into customers. They are also able to call on the support of a specialist sales team. John decided right at the start that he should make the most of these advantages to push up his income and profitability.
John could see the potential for gain and growth in the franchise. There are three ways of making money from a business: paying yourself a fair wage for the hours you put in; earning a return on the money you invest; and making a capital gain when you sell the business. The figures showed John that if he could increase sales, his annual profitability would improve. This would not only increase his return on investment but also increase the value of the franchise. That would mean a bigger capital gain when he eventually decided to sell it.
And John discovered that Fastway offered other options for increasing revenue, too. He was told that some couriers had made a capital gain by building up their areas then selling outlying parts and concentrating on a smaller territory. This made more efficient use of resources such as fuel and time. Alternatively, if he grew large enough he could also employ drivers (sub-contractors) as long as they were approved by the regional franchisee and the franchisor.
Although John had been able to use the figures supplied to work out his operating profit, this didn’t tell the full story of what he might actually earn. For that, he needed the help of an accountant who could both check the work he had done so far and help him to make the most of the opportunity (for more information on choosing an advisor, click here). John chose a specialist franchise accountant from the Directory. Following his example, we talked to Philip Morrison of Franchise Accountants, who numbers a Fastway courier franchisee among his clients, to go over the same figures with us.
The accountants pointed out that there were other aspects for John to consider that should be shown as deductions from the total operating profit. This was good news as it could reduce the amount of tax that he might have to pay on the profit.
For example, although John’s business will be conducted from his van, he would also probably have to set up some sort of home office and might also keep the van – his work vehicle – in his garage. This would entitle him to deduct a percentage share of his mortgage interest or rent from the business profits, meaning that these would be paid from his before-tax income rather than his after-tax income – a significant benefit. If he bought the vehicle outright rather than leasing it, he would be entitled to claim depreciation on his van, again reducing his taxable income. There was also GST to take into account: with sales over the $60,000 threshold, John would be required to register for GST. John would therefore need to maintain a simple system to ensure that he paid the correct amounts of GST on time. His accountant could help him to set up an easy-to-use accounting system that would handle his GST and bookkeeping, which sounded like a good idea – even though John had never owned a business before, he knew getting in trouble with the IRD would be bad. In many cases, this sort of administration is handled by the franchisee or a family member, although some employ accountants or bookkeepers to handle it for them. Even if the basic bookkeeping is handled by the franchisee, they will still need to employ an accountant to prepare their annual tax returns and this, too, needs to be allowed for.
Another area for John to discuss with his accountant was managing his cashflow to ensure that he had enough money in hand to pay bills and GST when they became due. Preparing a cashflow budget would enable him to see what he needed to have when, and save any nasty surprises. His accountant also advised John that, for every dollar he earned, he should set aside some for his tax bill – and not to get caught out by the tax ‘holiday’ new businesses receive in the first year. This holiday can be a great help when it comes to cashflow but means that outgoings on the tax bill in the second year are higher. Philip Morrison says failure to allow for this is the largest single cause of business failure.
These are areas that the franchisor cannot advise on because they are individual to a franchisee’s own situation. That’s why it was important that John worked with his accountant to ensure that he knew all the costs involved in running his business before he made the decision whether to buy. It also ensured that if he did go ahead, he would be able to set it up so that it provided the maximum possible return for him.
John’s situation was simplified by the fact that he was able to buy the business outright with money he had already saved. In addition, it was an existing business, so he was able to work with actual figures. Had this not been the case, though, John and his accountant would have had to consider the impact of other factors on his decision. These might include:
Finance If John had had to borrow the money to buy the business, he would have had to consider issues such as whether he had sufficient assets to provide security for the bank to lend against and the impact of interest and repayment charges on the profitability of the business.
Sales If John had established a new franchise territory from scratch, he would have had to take advice on how long it would take before the business became profitable. While a franchisor can predict costs with reasonable accuracy, predicting sales is harder. John and his accountant would want to look at various different scenarios before he made his decision.
Guarantee A courier franchisee in a new territory pays an establishment fee of $30,000, some of which is effectively paid back over 35 weeks to provide minimum income and working capital. If John were buying a new territory this would have to be taken into account in his calculations.
Having done all the sums and taken advice, John was now in a position to make a decision about whether to buy the business or not. According to the Profit & Loss account (Table 3), if he were paying tax at the 25% tax rate the projected profit after tax would be $40,593. With all the figures in place, he was also able to calculate his added income if he achieved an increase in sales of, say, 10% on pick-ups and redemption income.
However, there are other considerations with a small business like this and in addition to the financial return he was also interested in the lifestyle that the franchise could offer him. These included regular business hours, job security (he wouldn’t be made redundant), the opportunity to be master of his own destiny and the chance to improve his financial position. Whilst earning a very acceptable annual income, John could take on a business with growth potential which would provide a capital gain when he came to sell it.
In real life, John decided to go ahead and buy this Fastway courier franchise. Doing his homework had made him very aware of all the elements that went in to making his business profitable and, in particular, the importance of attracting additional customers. It’s something he reminds himself of every day – and it shows in his determination to give the best possible service.
This article first appeared in Franchise New Zealand magazine Volume 19 Issue 2 2010
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