How to Check a Franchisor’s Financial Position Before Joining a Franchise in Japan

When choosing a franchise brand, you need to consider not only your own outlet’s finances, but also whether the franchisor can continue supplying products and providing business support. A franchise is a community of independent businesses supporting one another, but a shortage of funds at the franchisor can affect franchisees’ operations too. Before signing a contract, check the franchisor’s financial position and make sure its explanations match the figures.

1. Check the basis for requesting financial information and which company it covers

In Japan, Article 11 of the Act on the Promotion of Small and Medium-sized Retail Business requires franchisors that fall within the Act’s definition of a ‘specified chain business’ to provide prospective franchisees with written information and explanations before a contract is signed. The franchisor’s financial position is among the matters covered by pre-contract disclosure. However, calling an arrangement a franchise does not mean that every contract carries the same disclosure obligations. Coverage depends on statutory criteria concerning matters such as product supply, business guidance, the use of trade marks and fees collected when joining.

The Japan Fair Trade Commission’s guidelines on the application of the Antimonopoly Act to franchise systems also apply to a broad range of franchises, not just retail and food service businesses. These guidelines explain how the Antimonopoly Act applies. It is important to distinguish between recommended disclosure practices and legally required disclosure.

The first thing to establish is whether the financial documents relate to the legal entity you will be contracting with. The company that owns the brand, the company signing the franchise agreement and the company supplying products may be different entities. Strong consolidated results for a parent company alone do not reveal the cash position of your contractual counterparty.

Match the legal entity named in the draft agreement against the company named in the financial documents. If related companies will provide support, clarify their roles too. Even if you are told that ‘the group will provide support’, do not assume that financial assistance will be forthcoming unless there are specific guarantees or commitments.

2. Obtain documents showing trends, not just one year’s results

Ask the franchisor for financial statements, including the balance sheet, profit and loss account and accompanying notes. In practice, comparing several recent financial years makes changes easier to identify. This is a request for analytical purposes: it does not mean that every document you choose to request must legally be supplied.

Organise the documents you want to review and their purposes as follows.

Document	Main purpose of review
Balance sheet	Assess cash and bank balances, borrowings and net assets
Profit and loss account	Distinguish profit from core operations from one-off gains and losses
Cash flow statement, if prepared	Assess cash generated or used by operating activities
Recent monthly financial information or similar records	Identify changes since the financial year end
Explanation of the loan repayment schedule	Assess upcoming funding requirements

Some companies do not prepare cash flow statements. In that case, ask what information they can provide about their cash flow outlook and loan repayment schedule. The absence of a document is not the same as a shortage of funds.

For each document, check the reporting period, the units used and whether it covers the individual company or the consolidated group, so that your comparisons are consistent. If some time has passed since the financial year end, also ask about any substantial new borrowing, capital expenditure or business disposals. Avoid judging the current position solely from old accounts.

3. Read profits, cash and net assets together

A profitable franchisor does not necessarily have enough readily available funds to meet its payments. Revenue may be recognised before payment is received, while loan repayments and capital expenditure can reduce cash balances. Start by examining these three areas together.

Is the core business profitable? Look at operating profit, not just the bottom line. If one-off gains, such as the sale of property or a business, have produced an overall profit, you need to assess the profits generated by normal operations separately.

Are there enough funds to meet payments? Check not only cash and bank balances, but also trade payables due shortly and loans approaching their repayment dates. Even if cash balances have risen, an increase funded by new borrowing does not necessarily indicate improved trading.

Is there a buffer against losses? If net assets are steadily declining, ask why and what action is being taken. Liabilities exceeding assets are an important warning sign, but this does not automatically mean the business will immediately cease trading. Consider access to finance and repayment terms as well.

There is no universal financial ratio that guarantees safety. A franchisor holding stock has different funding needs from one mainly providing business support. Rather than making a pass-or-fail decision based on a single year or indicator, ask a tax accountant or another suitably qualified adviser to help assess the reasons behind changes.

4. Check dependence on initial franchise fees and the ability to sustain support

For prospective franchisees, a particularly important question is whether the franchisor’s revenue model can sustain support for existing franchisees even if fewer new franchisees join. Growth in the franchisor’s total revenue does not, by itself, reveal where that revenue comes from.

As far as possible, ask for an explanation of the revenue mix: initial franchise fees and other opening-related income, ongoing royalties, product supply, company-operated outlets and other sources. Even if a detailed breakdown is not disclosed, you can still ask what generates most of the profit and how the franchisor would respond to a slowdown in recruitment.

Specific questions like these can give you more useful information during meetings:

• If new outlet openings fall below plan, how will you secure the budget for franchisee support?
• What has caused the recent decline in profits or cash and bank balances?
• What funding plans are in place for substantial loan repayments?
• If related companies handle product supply or support services, how do you assess their ability to continue doing so?

A high proportion of income from initial franchise fees does not, in itself, indicate improper management. Helping franchisees open outlets costs money. What you need to establish is whether ongoing services for existing outlets depend on an uninterrupted flow of fees from new franchisees.

5. Resolve outstanding questions before deciding to join

Do not accept a conclusion such as ‘the loss is only temporary’ without checking the causes, proposed improvements, implementation timetable and evidence that the necessary funding is available. Record when explanations were given and which periods the documents cover. Send follow-up questions if anything conflicts with the financial statements.

There may be reasons for withholding documents, including confidentiality concerns. Discuss alternatives, such as inspection without receiving copies, disclosure limited to your professional advisers, or explanations supported by summary information. However, avoid filling important gaps in your understanding with the assumption that a well-known brand must be sound.

A tax accountant or certified public accountant can review the financial figures, while a lawyer can advise on your rights and contractual options if support stops. This allows you to assess the issues separately. A financially healthy franchisor does not guarantee the success of your own outlet. Equally, understanding a franchisor’s weaknesses can help you decide not to proceed or to reconsider your plans.

Practical takeaway: compare several years of financial information for the company you will be contracting with, focusing on ‘profits from core operations’, ‘funds available to meet payments’ and ‘revenue sources that sustain support’. Do not rush into signing while significant unexplained changes remain.