Working capital: how to calculate it before franchising your business

A business can make a profit and still run out of money to pay wages or replenish stock. Before turning your business into a franchise, you need to understand how much cash a new unit will use before it becomes self-sustaining. In franchising, this analysis helps make investment requirements more transparent and prevents prospective franchisees from starting out with insufficient funds.

1. Separate set-up investment from working capital

Set-up investment covers expenditure such as building work, equipment, fit-out and other costs needed to get the unit up and running. Working capital, by contrast, bridges the gap between paying bills and receiving sales proceeds, while also covering shortfalls as the operation gets established.

This distinction avoids a common mistake: assuming that funding needs end when the shop opens its doors. Rent, payroll, taxes and stock replenishment still have to be paid, even when trade is slower than expected.

Organise the budget into three categories:

• Set-up: pre-opening expenditure, with expected payment dates.
• Operations: cash inflows and outflows after opening, including commitments made beforehand.
• Contingency reserve: a financial buffer for potential variations identified in the risk analysis.

Take care not to count the same amount twice. If opening stock is already included in the set-up budget, record its purchase only once in the cash flow forecast. Then forecast replenishment according to stock usage and payment terms.

Keep the business owner's personal finances separate too. Family savings should not be treated as cash available to the unit. However, the planned remuneration for the franchisee's work must be included in business expenses.

2. Build the cash flow forecast around actual payment timings

Use the existing business's records as a starting point, rather than assuming they will automatically reflect the future operation. A new unit may have different trading terms, rent and sales patterns from an established business.

Gather bank statements, sales reports, accounts payable records, stock data and accounting records. Review a period long enough to identify seasonality, rather than selecting only the best months. Explain any gaps in the data used.

Prepare a weekly forecast for the initial phase and a monthly forecast for the period that follows. For each period, record:

• Actual cash receipts, allowing for instalments and settlement times for different payment methods.
• Supplier payments based on due dates, not just purchase dates.
• Payroll, employment-related charges, rent, services, taxes and administrative expenses.
• Expected financial obligations under the franchise arrangement and stock replenishment.
• Opening balance, net cash movement and closing balance.

A sale is not a cash receipt, and profit is not a bank balance. A sale paid in instalments may generate revenue now, while the money arrives only after significant expenses have fallen due.

Do not assume that advantages specific to the founder will carry over into the forecast without justification. Preferential payment terms from a long-standing supplier, owner-occupied premises or unpaid family labour can conceal funding needs that will arise in the franchised unit.

3. Calculate the funding requirement and test adverse scenarios

To estimate the funding needed, identify the largest cumulative shortfall in the cash flow forecast, before any funding injections intended to cover it. This shows how much money would be needed to prevent the balance from becoming negative, based on the assumptions used.

If the forecast also includes set-up costs, the shortfall will represent the total funding requirement, not just working capital. Show the components separately and deduct only funds that are genuinely available, avoiding double counting.

Then test different scenarios. Rather than adding an arbitrary reserve, examine specific situations:

• Opening is delayed, but rent and some staff costs already need to be paid.
• Sales grow more slowly than expected.
• A supplier shortens its payment terms.
• Stock losses occur or purchases need to be made earlier than planned.
• Cash receipts take longer to arrive than expected.

Record which assumptions changed and how they affected cash flow. The contingency reserve should address these risks, without being presented as a guarantee against every unforeseen event.

Also define warning signs that should trigger a review of the estimate, such as a delayed opening, a significant change in rent or changes to supplier terms.

4. Present the estimate transparently and in line with legal requirements

In Brazil, Law No. 13,966/2019, the Franchise Law, requires the Franchise Disclosure Document, known locally as the Circular de Oferta de Franquia (COF), to state the estimated total initial investment needed to acquire, establish and begin operating the franchise. It also requires information on premises and fit-out, equipment, opening stock and recurring payments.

The law does not prescribe a universal working capital amount or a mandatory calculation formula. Setting out this requirement separately and explaining the underlying assumptions is therefore a transparency measure that should be agreed with legal and accounting advisers.

As a general rule, the COF must be provided at least ten days before the franchise agreement or preliminary agreement is signed, or before any fee is paid to the franchisor or a person or company connected with it. Estimates used in sales materials must be consistent with this document and must not promise guaranteed results.

In practice: before offering the franchise, prepare a cash flow forecast based on actual payment timings, identify the largest shortfall and document the risks. Responsible franchising starts with knowing how much money the operation needs to keep running.