Before franchising: how to assess replicable profit

A profitable business does not necessarily make an economically viable franchise. Its current results may depend on owned premises, unpaid family labour or trading terms that someone else could not secure. Before becoming a franchisor, it is worth answering one specific question: how much of that profit would survive in a unit run by someone else, under the proposed franchise terms?

1. Reconstruct the operation’s true financial results

Start with a monthly management profit and loss statement, reconciled with accounting records, sales and expenses. Do not treat the bank balance as a synonym for profit: advance receipts, loans and deferred payments can conceal a loss-making operation.

Organise the figures in a consistent sequence:

• Sales revenue, with cancellations and discounts identified.
• Taxes on sales and variable costs, such as goods, materials, commissions and payment processing fees.
• Contribution margin: the amount remaining to cover fixed expenses and generate profit.
• Fixed expenses, including premises, staff, systems, maintenance and administration.
• Operating profit or loss, with a clear indication of which items are included and excluded.

Use a period that captures seasonality, promotions and difficult months. If the business has not yet been through its full seasonal cycle, record that limitation rather than treating its best months as the year-round norm.

Also separate out exceptional events, such as an unusually large sale or a refurbishment. These should not disappear from the analysis, but they need to be identified so they do not distort the picture of recurring performance.

2. Remove advantages that will not carry over to the franchise

The key step is to calculate profit adjusted for replication. This means replacing the founder’s particular circumstances with assumptions appropriate to the future franchise unit.

If the business operates from premises it owns, allow for a market-rate occupancy cost. If family members work unpaid, include the cost of the roles they perform. If the founder serves customers, buys stock and manages the shop, assign an economic value to that work.

This does not mean assuming that every franchisee will hire a manager. The analysis should reflect the involvement required of the operator and distinguish remuneration for work from a return on investment. A profit that merely pays the owner for working long hours does not automatically make an attractive investment.

Also review terms and circumstances that may not be transferable:

• Purchasing discounts linked to the existing business’s total volume.
• A long-standing rent below current market rates.
• Marketing driven by the founder’s personal reputation.
• Equipment that has already been depreciated but will need replacing.
• Administrative expenses absorbed by another company in the group.

Include the charges proposed under the franchise model and any compulsory third-party services, without counting expenses twice. Confirm the tax treatment with an accountant: it is not safe to assume that the original operation’s tax burden will automatically apply to every future franchisee.

3. Test the resilience of profits, not just their average

Once the adjustments are complete, build realistic scenarios. The aim is not to choose an arbitrary percentage decline, but to investigate specific risks: fewer customers, rising input costs, a change in the sales mix or the need for more staff.

Calculate the operating break-even point by dividing fixed expenses by the contribution margin ratio, expressed as a decimal, provided the classifications are consistent. This indicator shows the revenue needed to cover the costs included in the calculation; on its own, it does not demonstrate recovery of the investment or the ability to meet loan repayments.

Compare that revenue with the operation’s actual capacity to serve customers. If breaking even requires more sales than the team and equipment can deliver, the problem lies in the unit’s economic model.

Watch for step increases in costs, too. Higher sales may require another employee or an additional piece of equipment, reducing the expected gain. Do not project growth as though all expenses will remain unchanged.

Set internal criteria for proceeding: the operator’s remuneration is accounted for, the business generates a profit under plausible conditions, and capacity is sufficient to support the required turnover. If the figures only add up under optimistic assumptions, adjust the model before offering it to prospective franchisees.

4. Turn the analysis into responsible disclosure

In Brazil, Law No. 13,966/2019, the Franchise Law, governs business franchising. It requires the Franchise Disclosure Document, known locally as the Circular de Oferta de Franquia (COF), to include, among other information, the estimated initial investment, fees, and the franchisor’s balance sheets and financial statements for the two most recent financial years.

The franchisor’s financial statements are not a substitute for an economic analysis of the franchise unit. Nor does the law establish a minimum profit or, as a general rule, require a business to have operated for a year before it can begin franchising.

If you present financial scenarios to a prospective franchisee, distinguish historical data from projections. State the period covered, the source of the data, the characteristics of the operation analysed, and the adjustments and assumptions used. Avoid presenting a payback period as a guarantee.

The COF must be delivered at least ten days before any contract or preliminary agreement is signed, or any fee is paid to the franchisor or a person or company connected with it. Have the sales presentation reviewed by a legal adviser to ensure its claims are consistent with the disclosure documents.

Practical conclusion: before selling your first franchise, prepare an adjusted profit and loss statement and test its assumptions. Proceed when profitability depends on a transferable business model, not on advantages unique to the founder.