Define the Basis for Calculating Franchise Royalties in Malaysia

When an established business is ready to build a franchise network, setting the royalty rate is only part of the task. Both parties also need to understand which sales figures form the basis of the calculation. App orders, vouchers, cancellations and refunds can produce different totals even when the same rate is applied. This guide focuses on establishing a clear, verifiable and practical basis for calculating royalties before the first franchisee starts trading.

1. Distinguish the royalty rate from the calculation basis

The royalty rate answers the question: “What percentage or amount is charged?” The calculation basis answers: “Which figure is that charge applied to?” Ambiguity over the second question often leads to disputes, even when the rate has been agreed.

In Malaysia, franchising is specifically regulated under the Franchise Act 1998 [Act 590]. Section 21 provides that, where a franchisee is required to pay franchise fees or royalties to the franchisor, the rate must be as stated in the disclosure document. Section 18 requires the franchise agreement to be in writing.

Do not, therefore, leave the meaning of “sales” to the accounting team's usual practices. Set out the calculation basis in the agreement, include the relevant disclosures, and explain how to apply it in the financial procedures. Ask a lawyer to check that the wording complies with the Act and does not create conflicting obligations.

If royalties are based on a percentage of sales, the working formula can be expressed as sales subject to royalties × the agreed rate. This is a calculation framework, not a mandatory rate or formula prescribed by law.

2. Decide how each type of transaction will be treated

Start with a list of actual transactions from the existing business. Do not rely solely on examples of cash sales at the counter if customers also buy through delivery apps or online channels.

For each transaction type, decide whether its value is included in the royalty calculation basis, excluded or subject to adjustment. Pay particular attention to the following:

• Discounts: Distinguish discounts funded by the franchisee from promotional subsidies paid by another party.
• Refunds: Specify the evidence required and the reporting period for deducting sales that have been refunded to customers.
• Cancellations: Distinguish orders cancelled before payment from transactions that have been paid for and subsequently cancelled.
• Vouchers or gift cards: Define when their value is recognised so that the same amount is not counted both when sold and again when redeemed.
• Taxes and charges: Clarify the treatment of taxes collected, service charges and delivery charges, reflecting how transactions actually work.
• Platform commissions: Decide whether the calculation is based on sales before commission or the amount remaining after agreed deductions.

For example, payments received from a delivery platform may already have had commission and promotional adjustments deducted. The amount deposited in the bank is not necessarily the same as the sales figure used to calculate royalties.

No single commercial approach suits every business model. What matters is that the chosen approach is clearly stated and that the calculation can be produced from business records without monthly guesswork.

3. Establish a monthly reporting and review process

Once the definitions have been agreed, identify the primary data source. The sales system may provide the transaction record, while platform reports explain deductions and bank statements confirm receipt of funds. Each serves a different purpose; do not assume that one record can replace all the others.

Prepare a royalty reporting template showing sales by channel, permitted adjustments, the final calculation basis, the rate and the royalty amount. Every adjustment should have a transaction reference and a reason that can be checked.

Set out a practical workflow:

1. The franchisee closes the sales records for the relevant period.
2. A designated person reviews unusual transactions and supporting documents.
3. The report is submitted to the franchisor for review.
4. Discrepancies are resolved or recorded as outstanding matters.
5. Payment is made by the date and method specified in the agreement.

State who may approve adjustments and how corrections made after the month-end close will be recorded. Avoid making unrecorded changes to earlier reports; maintain a correction log so that both parties can trace their effects.

The right to obtain supporting records, retention periods and the method for resolving discrepancies should also be agreed. Limit access to the data needed for royalty reviews and protect customer and employee information.

4. Test the calculation before collecting the first payment

Use a set of anonymised real transactions to test the formula. Ask two people to calculate the royalties independently using the same instructions. If their answers differ, identify the cause: unclear definitions, incomplete reports or unexplained adjustments.

Include challenging cases such as refunds issued in the following month, vouchers redeemed at a different outlet and jointly funded promotions. The purpose of this test is not to assess outlet performance, but to ensure that the royalty rules produce consistent results.

Prepare worked examples to explain the calculation to prospective franchisees. Make clear that these examples help explain the formula; they are not promises of sales or profits. If the rules are to be changed later, check the contractual requirements and any relevant approval requirements of the Registrar of Franchises before implementing the changes.

Practical takeaway: Before collecting the first payment, make sure that the same transaction produces the same royalty calculation for both franchisor and franchisee. Clear definitions, well-organised supporting evidence and a transparent correction process help maintain trust across the franchise network.