Buying a franchise: how to assess projected profitability

An attractive profit forecast does not prove that your future franchise will be profitable. Before joining a franchise network, you need to understand the data behind the figures, which costs are missing and how much the results depend on the owner’s work. The key is not to ask for a promise of profits, but to turn the sales presentation into a profit and loss account you can verify.

1. Distinguish actual results from estimates

Start by classifying each document you receive: historical accounts for individual outlets, network averages or projections for your future outlet. These are not interchangeable. An established business may have repeat customers and rental terms that a new outlet does not yet have.

In Spain, Article 62 of Law 7/1996 on Retail Trade and Article 3 of Royal Decree 201/2010 govern pre-contractual information. This must be provided in writing, be truthful and not misleading, and be delivered at least twenty working days before you sign a contract or preliminary agreement, or make any payment to the franchisor.

The Royal Decree also stipulates that any sales or operating results forecasts provided must be based on sufficiently substantiated experience or studies. This does not turn a forecast into a profit guarantee, nor does it require every franchise offer to include a profit projection.

Ask for the basis of the figures: the period analysed, the outlets included, the calculation method and the assumptions used. If confidentiality is raised as an issue, suggest anonymised data that allows you to check the comparison without identifying other business owners.

2. Check whether the sample is comparable to your business

An average can conceal significant differences. Ask whether it includes company-owned and franchised outlets, recent openings and established businesses, or only outlets with favourable results. It is also worth checking whether outlets that ceased trading during the period have been excluded.

To assess how useful the sample is, review these variables:

• Format and size: floor area, customer capacity and services offered.
• Location: footfall, customer profile and the characteristics of the surrounding area.
• Trading history: months since opening and the time needed for sales to stabilise.
• Organisation: opening hours, staffing and work contributed by the owner.
• Accounting basis: sales excluding VAT, discounts, returns and the expenses included.

You do not need every outlet to be identical. You need to understand what adjustments the comparison requires. If available, ask for the median and the range of results as well as the mean: these help reveal whether a few outlets are substantially inflating the figure presented.

An annual projection should also be broken down by month. Simply dividing sales by twelve can hide seasonality, holidays or a slower start to trading.

3. Recalculate profit using all costs

Use your own spreadsheet and separate sales, variable costs and fixed costs. Confirm that all amounts are treated consistently, particularly in relation to VAT. Recoverable VAT is not treated in the same way as a cost ultimately borne by the business, although it can affect cash flow.

Variable costs may include stock, consumables, payment processing fees and charges calculated as a percentage of sales. Fixed costs may include rent, staff, insurance, professional fees, utilities and fees that do not depend on turnover. Some items will have both fixed and variable components.

Include reasonable pay for your own work, even if you initially decide not to draw it. A positive result achieved through unpaid work by the owner can give a misleading picture of the business’s underlying profitability.

Also clarify what ‘profit’ means in each document. EBITDA is not the same as net profit or available cash. Depreciation, amortisation, interest and tax can change the result; repaying the principal of a loan uses cash but is not an expense in the profit and loss account.

4. Calculate break-even sales and test the assumptions

The break-even point helps you estimate how much you need to sell to cover the costs included in your calculation. A basic formula is:

Break-even sales = fixed costs / contribution margin ratio.

The contribution margin ratio is the proportion of sales remaining after variable costs have been deducted. The formula assumes a relatively stable sales mix and cost structure; it becomes less accurate if you need to increase staffing or capacity as the business grows.

Prepare a base-case scenario and a downside scenario. Reduce sales, allow more time for them to stabilise, and check the impact of a lower margin or higher labour costs. Identify which assumption would make the business unviable and scrutinise it before committing.

Practical conclusion: do not base your decision on a single profit figure. Insist on a clear, verifiable explanation of the forecasts, and work with an independent accountant to assess whether the sales required are realistic for your outlet.