Franchise profitability: factor in the true cost of the owner’s work

A successful outlet is not automatically a sustainable foundation for a franchise network. If the owner handles sales, staff rotas and administration every day without being paid appropriately for that work, reported profit may conceal the true cost of running the business. Before offering an existing business model to a prospective franchisee, check whether the outlet remains profitable when all the work required is properly costed.

1. List the work the owner does behind the scenes

Start with the tasks, not the year-end accounts. Over a representative period, record what the owner does, how much time it takes and who would take over if they were unavailable. Include regular shifts, preparation before opening, purchasing, staff rotas, financial administration, local marketing and emergency cover.

Flag any activities carried out by family members or employees of another business owned by the same person. Just because the outlet receives no invoice for their work does not mean it is free or will be available to a future franchisee.

For each task, record:

• the hours required and how often it needs doing;
• the skills and level of responsibility involved;
• the person or external provider who could take it on;
• the estimated total cost of replacing the owner’s input.

Do not assume that one manager will always be enough to replace the owner. The owner may be delivering a specialist service, managing a team and developing sales at the same time. These roles may require different people. The reverse also applies: there is no need to cost every role as a separate full-time position if the workload does not justify it.

2. Prepare an adjusted profit calculation for the outlet

The next step is not to change the statutory accounts, but to prepare a separate management calculation. This estimates the financial result the outlet would achieve under realistic, replicable operating conditions.

Start with actual revenue and expenses for a period that captures normal seasonal variations. Then work with an accountant to check which adjustments are justified. If payment for the owner’s work is already included in expenses, do not add the full replacement cost again: add only the necessary difference.

Beyond the owner’s work, check whether the outlet occupies premises rent-free, shares accounting services with another business or receives particularly favourable rates because of personal relationships. These advantages should not automatically be removed, but you should clearly identify whether a new franchisee would be able to secure them.

A useful summary has three columns: recorded amount, justified adjustment and adjusted amount. Every adjustment should have supporting evidence, such as a service quotation, employee cost data or a quotation for comparable rental premises.

When modelling a future franchised outlet, also include the expected contractual fees and other compulsory costs of belonging to the network. An existing company-owned outlet may not incur these costs. Without them, the comparison is incomplete, even if revenue has been realistically estimated.

3. Separate payment for work from return on investment

A prospective franchisee may intend to run the outlet personally. That is a legitimate choice, but their work is not the same as a return on invested capital. If all the money left over amounts to payment for working daily shifts, the business may provide a job without yet demonstrating a satisfactory return on investment.

Prepare two clearly labelled scenarios:

• The franchisee runs the outlet personally: include a fair value for their work and show the remaining profit or loss separately.
• An employed manager runs the outlet: include the manager’s total employment costs and any cover needed during absences.

For both scenarios, test what happens with lower sales, higher labour costs or a longer start-up period. Base your assumptions on your own operating experience and local quotations, rather than on the result you want to present.

Prepare a separate cash flow forecast too. Accounting profit is not the same as available cash: loan principal repayments, investment in equipment and increases in stock can put pressure on cash flow without having the same effect on profit in that period. The tax position also depends on the business structure and the franchisee’s circumstances, so it needs to be assessed separately.

4. Set a condition for proceeding with franchise development

Before presenting the opportunity to candidates, decide what the adjusted calculation must demonstrate. The outlet should be able to cover its true labour costs, contractual commitments and routine operating needs, with a reasonably substantiated margin for a return on investment. There is no universal threshold suitable for every franchise network.

If the result depends on the owner continually working without pay, first change the way the business is organised or the economics of the offer. Do not conceal the problem by assuming that the future franchisee will simply work harder.

Croatia has no dedicated law comprehensively governing franchising, nor a prescribed statutory format for pre-contractual franchise disclosure. Negotiations and the contractual relationship are governed by the Croatian Obligations Act, including the principle of good faith and fair dealing. Depending on the nature of the relationship, other general legislation also applies, such as the Croatian Competition Act. The absence of a prescribed disclosure format does not justify presenting results in a misleading way.

Keep the evidence supporting your calculations, distinguish actual results from projections and do not present projections as a guarantee of earnings.

Practical takeaway: before developing a franchise, prepare an outlet profit calculation that assigns a fair cost to all the owner’s work. Only then assess whether you are offering a future partner a sustainable business or one that survives through hidden personal sacrifice.