Franchising: building a franchisee profit and loss forecast

A business that is profitable for its founder will not automatically deliver the same results for a franchisee. Before offering your franchise, you need to understand what margins an independent operator can achieve after all necessary costs. Building a franchisee profit and loss forecast gives your future franchise network a verifiable foundation, without turning a business forecast into a promise of earnings.

1. Start with actual results, but adjust for exceptional circumstances

Take the figures from your existing business: revenue, purchases, staffing, rent, utilities, maintenance and other operating expenses. Use a period that captures seasonality, rather than selecting only the best months. Also separate ordinary revenue from income generated by one-off events.

The crucial step is normalising costs: replacing conditions specific to your business with terms that a franchisee could realistically obtain.

For example, if you work in the outlet every day without paying yourself, the apparent margin conceals the cost of your labour. Include either an assumed remuneration for the franchisee’s work or the cost of employing someone to perform that role in your management model, making clear which approach you have taken. Do not confuse this management adjustment with an expense that is tax-deductible under every legal structure.

Pay particular attention to:

• premises you own or unusually favourable rents;
• unpaid or underpaid work by family members;
• personal discounts granted by suppliers;
• equipment that is already fully depreciated but would need to be purchased for a new outlet;
• customers attracted by the founder’s personal reputation.

Keep a table showing the original figure, the adjustment and the reason for it. The result should describe a business that is viable for someone joining the network, not just for the person who created it.

2. Link every forecast to a testable assumption

Do not start with a target turnover and work backwards to produce convincing figures. Instead, build revenue projections from observable variables. For a shop, these might be daily transactions, average transaction value and trading days; for a service business, the number of services that can be delivered, the average price and the utilisation rate of available capacity.

Every variable should have a source and clearly stated limitations. The average transaction value recorded at the original outlet, for example, may reflect a different customer base from that of the planned opening. Make clear when a figure is historical and when it is an assumption that needs to be tested locally.

Prepare three scenarios: cautious, base case and favourable. Do not simply vary revenue: also consider the time needed to establish the business, wastage, initial productivity and staffing requirements. Some costs rise in steps: once a certain operating capacity is exceeded, an additional member of staff may be needed.

Then calculate the operating break-even point, using consistent fixed-cost and contribution-margin assumptions. Include royalties and any other proportional charges in variable costs, where applicable. Specify which items are excluded: reaching operating break-even does not necessarily mean providing a return on capital or repaying a loan.

3. Support the profit forecast with a cash flow plan

A profit and loss forecast alone cannot establish how much cash will be needed. A business may show a profit yet still run out of cash because it has bought stock, paid deposits or allowed customers time to pay.

Prepare a monthly schedule of cash receipts and payments for the start-up period, extending it far enough to show how normal trading will work. Keep the following separate:

• initial capital expenditure, fit-out and equipment;
• the initial franchise fee and other contractual payments;
• opening stock and subsequent replenishment;
• security deposits and advance payments;
• operating costs while revenue builds;
• taxes, VAT and loan repayments, as applicable to the particular business.

Avoid double counting: buying equipment affects cash flow, while its cost is recognised in the profit and loss account through depreciation. Repayment of loan principal is not a profit and loss expense either.

Identify the lowest cumulative cash balance and explicitly state any additional contingency reserve. Have an accountant review the model, particularly the tax treatment, employment costs and the franchisee’s legal structure.

4. Present the figures without promising results

In Italy, franchising is governed by Law No. 129 of 6 May 2004. The agreement must be in writing to be valid and must state, among other things, the amount of investment and any entry fees required before trading begins. Article 4 requires the complete agreement and the prescribed annexes to be provided at least thirty days before signing.

The law does not expressly require a business plan as a mandatory annex. However, any forecasts supplied voluntarily must comply with the duties of loyalty, fair dealing and good faith that apply during pre-contractual negotiations. A statement such as “results are not guaranteed” does not make unsupported figures reliable.

Date every version of the model, identify the sources and distinguish historical results, adjustments and estimates. Ensure that sales presentations, financial projections and contractual terms are consistent. Encourage prospective franchisees to check the assumptions with their own advisers, without suggesting that doing so transfers your responsibility for the information you provide.

In practice: before offering a franchise, prepare a normalised profit and loss forecast, three reasoned scenarios and a cash flow plan. If viability depends on circumstances unique to the founder that cannot be replicated, revise the proposition before seeking franchisees.