by Leith Oliver
last updated 23/07/2009
Measurement & Management
by Leith Oliver
last updated 23/07/2009
Most people would agree that in any business the main objective is to make money. What is not so clear is the question of how!
In small businesses, profits depend to a great extent on an individual owner or manager who is subject to a wide range of influences. These range from their operational efficiency and marketing effectiveness through to issues of financial management skills and staff motivation and training.
It is therefore small wonder that most franchisors would say that the individual franchisee is the factor that makes the greatest difference in performance between areas. However, for a franchisor the problem of managing the group's performance is exaggerated still further by the geographical spread of the franchised business units, and the lack of reliable management information.
In the search for profitable operations, the trick is first to find out what works and what doesn't, and then to stop making mistakes. The precious resources of time and capital can then be switched from unproductive areas into the areas that do produce the results. This is basically what franchising is about – helping franchisees maximise their return for the effort and investment they put in.
But for franchisors and franchisees to achieve their fullest potential, there need to be measurements or indicators within the franchise that are guides to success and profitability – both now and in the future. These are known as Key Performance Indicators (KPI's). Ideally they should come from all four areas of management - marketing, operations, staff, and financial.
The first place to start is often the financial management area because financial information and reports probably already exist, even if they are produced only once a year for IRD requirements. The process of financial analysis and diagnosis is done using a tool kit of key financial ratios that fit into five categories - efficiency, sales, profitability, financial structure and liquidity.
Don't be put off by these technical terms – the steps themselves are relatively simple. The meaning of each ratio and the method of calculating each one is outlined in the chart below. By plugging your own figures into this chart, you can create a portrait of your business which will help you to manage it better – and improve the return you receive.
The task of diligent financial management is to know what to look for and regularly analyse the business to discover undesirable trends. This enables corrective action to be taken in time to do some good. The analysis is done by relating pairs of figures together from the Balance Sheet and Profit & Loss Account to arrive at key financial performance indicators for the business.
Although the annual accounts might be a good starting point, the delay in their production means that the information is often so old that it is too late to take corrective actions. Obviously, businesses need to have monthly in-house accounting reports that give current data to work with.
With monthly accounts and the use of the following ratio analysis, a franchisee can control the financial direction of their individual franchise, and the franchisor can benchmark results across the group to help improve overall group performance. When all franchisees contribute KPI's to a performance management system, the franchisor can provide a monitoring service to the group that identifies individual franchisee performance in need of support and diagnoses where the trouble lies for that franchisee.
You are now in a position to analyse the financial performance of your business. All of these ratios measure the performance results of the franchise in important areas but some are more immediately critical than others. You will note that some areas are dependent on the standards normal in individual industries. This emphasises the value of franchisors gathering that information, and of franchisees sharing information on what is standard in their own particular system.
Although different industries will have different focuses, the more critical ratios are as follows.
Cash flow gives the business the ability to breathe and to live, so the liquidity ratios should be monitored closely - monthly at least. A deteriorating trend in the current ratio indicates a developing cash flow problem. Early detection gives the owner time to take corrective action.
2. Gross Profit Margin
The first financial rule of business is to maximise the gross profit margin. Many franchised products and services feature a fixed discount rate, or supply controlled through the franchisor or buying group. Larger margins are often only available by adding extra services that can enhance the product sales and lift the gross margin. But first, make sure you are getting the margin you should be getting. Watching the gross margin closely is a quick way to check for common profit 'leaks' in the system - theft (cash or stock), wastage of materials and low staff productivity.
3. Return on Equity
From a financial perspective, the decision to invest in a business has the same requirement as any other investment situation. Capital must be rewarded at a level appropriate to the riskiness of the investment. In most franchised businesses this required rate of return on the owner's funds is likely to lie somewhere around 20 - 25%. This means that after the owner has taken a reasonable salary the remaining net profit before tax for the year should be about 20 - 25% of the owner's funds invested in the business (usually labelled on the balance sheet as Total Owner's Equity or Total Shareholder Funds).
WARRANT OF FITNESS
With enough information to create an 'ideal' set of ratios, a franchisor (or franchisee) can now construct a model check list or 'Warrant of Fitness' for evaluating any business, whether in retail, food or services. This model originated from work done by Richard Higham in the Business Development Centre at the University of Otago in 1986. It has evolved through many years of lecturing, research and consultancy and has had inputs from others along the way.
The WOF check (see previous page) provides a quick and accurate way of rating the financial health of a small business, and should form a part of every franchisor's toolkit for assisting franchisees. Franchisees should be aware that in order to gain full benefit, they will need to share their figures for the mutual benefit of everyone in the system.
On the left hand side, financial information is taken straight from the accounts and the actual percentages for each figure are calculated and entered. To the side of those figures, the franchisor enters the percentages that would describe an ideal (model) franchise. On the right hand side of the WOF, a series of ratios is calculated and compared to 'ideal' performance ratios.
You will notice that the WOF includes some non-financial checks as well, which are aimed at identifying the likely success or otherwise of the business in the future.
The purpose of developing Key Performance Indicators and the Warrant of Fitness is to help franchisors and franchisees understand their businesses better, and help them perform better.
One of the benefits of belonging to a franchised family of businesses is that knowledge and information that can help to improve performance can be shared and learned by all the members. The collective wisdom of the group can develop a set of 'best practice' routines that gives the franchised system enhanced competitive advantage.
The development of an ever-improving organisation that outpaces its competitors requires the application and involvement of every member of the organisation. A Franchise Advisory Council may provide a forum for the discussion and communication of ideas in franchise systems, but the action towards benchmarking superior performance needs to be more pro-active in nature.
Franchisees will always range in their performance from very good to very poor, with the bulk clustered in the middle. The power of pro-active benchmarking is that by sharing this knowledge and acting upon it, the poorer franchisees can be helped to improve and the average franchisees lifted nearer to the top performers.
This article can only outline some of the tools available in the benchmarking process, but I would urge anybody whose appetite has been whetted to use the entry criteria for the WestpacTrust Franchise Awards as the next step. These Awards encourage you to evaluate your business in each of seven key business areas, and considerable assistance is available from the Franchise Association and the New Zealand Quality Foundation to help you do so (see page 70).
Performance measurement is a logical management process in any franchised system, and there are a considerable number of remarkably flash software and hardware options available now which can assist in the gathering and analysis of the necessary information.
However, I observe that a large number of franchisees in New Zealand franchise systems do not have in-house accounting software or any other type of information systems in place. This is an area of weakness in which some New Zealand-based franchises may be particularly vulnerable compared to larger overseas-originated systems.
I therefore close with a few words of warning. The cost of setting up these types of systems is not in the technology. Things move very quickly in the information technology world and the cost is continuously dropping. The real cost is in analysing the system requirements, in design and implementation, and in training. If your franchise is not progressing down this road while your competitors may be - get moving. You haven't got much time to catch up!
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