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As a business owner, you have to know exactly where it is that your books move out of the red and into the black. It might take a little while before a newly opened business sees a profit, so it’s imperative to know how much you need to do in sales to cover and hopefully far exceed your fixed operating costs.
The Initial Franchise Investment
The amount you pay upfront when signing a franchise agreement is not your total initial
investment. Between signing the contract and your grand opening, you will have several expenses to cover, from real estate and construction costs to marketing, staffing, and initial inventory.
To get a clear picture of what your total initial investment will be, consult Item 7 of the FDD. This portion of the FDD breaks down the estimated initial investment and provides high and low estimates for each anticipated expense.
In general, the initial investment range provided in the FDD should cover the capital needed to open a franchise location and cover the first three months of operation.
How much are you willing and able to invest? How much of a reserve does that leave you with until you reach breakeven? Assets to consider include:
- Savings
- Money market accounts
- Stocks/bonds/mutual funds
- Asset-based lending, such as home equity
One of the largest expenses listed in item 7 of the FDD, the estimated initial investment, is your build-out cost (at least for brick-and-mortar franchise businesses).
Whether building from scratch or renovating a current structure, you’ll need to design or modify the space to satisfy brand standards and help your business run more efficiently. Build-out costs include construction and modifications, equipment and furnishings, lighting and electrical, and design.
Other start-up costs will include initial inventory, staffing, and training. You’ll also need to know the estimated average working capital you’ll need for weekly expenses such as payroll, rent, utilities, and insurance.
At this point, it’s not necessary to figure out exact calculations, but having estimates will help you better compare franchise opportunities and assess what makes the most financial sense.
As mentioned before, item 7 of the FDD will provide average ranges for these expenses, but researching your specific market will be important in developing realistic expectations.
What Is Breakeven?
Breakeven is where revenue and costs intersect. When calculating your breakeven, you will want to evaluate your objective. There are two types of breakeven to take into consideration.
Total Investment Breakeven:
This is when you have fully recouped all of your invested and operating capital. It is typically calculated by total cash in and total cash out. This is also how you calculate your return on investment:
(Total Cash Returned / Total Investment) = Return on Investment
Breakeven is when this number reaches 1.0. Anything greater than 1.0 means you have achieved profitability and are generating a positive return.
Monthly Cash Flow Breakeven:
Simply put, this is when your revenue matches or surpasses your monthly expenses. Typically, you will only include routine monthly costs and not one-time expenses in this calculation.
Complete Your Own Breakeven Analysis
You will use your breakeven calculation to formulate your target profit and sales goal.
Once you’ve calculated your breakeven number:
- Consider other debts to be paid and ROI to be distributed (as income to you and your partners)
- Calculate the sales needed per month to achieve your profit goal
- Repeat this process for your annual sales goal analysis
Breakeven Point Formula:
(Total Cash Returned / Total Investment) = Return on Investment
Fixed Costs / (Sales Price per Unit - Variable Costs per Unit) = Sales Goal for Breakeven
Net Sales - Total Operating Expenses = Operating Income
(Operating Income + Interest Income) - (Interest Expense + Other Expenses) = Total Expenses
Pre-tax Income - (Income Tax Provision + Equity-method Investment Activity) = Net Income
Return on Investment (ROI)
As a part of the research process, you’ll want to collect information on what you can reasonably expect as a return on your overall investment.
No franchisor can guarantee a certain amount of revenue. Your earnings will depend on many factors, some of them stemming from your specific location and market and others from how you run your business, including marketing, sales, customer service, staffing, and more.
Some franchisors will include a financial performance representation in Item 19 of the FDD to help you get an idea of what to expect. These numbers represent one or more franchise locations’ actual performance, but it’s not a guarantee or promise of your success.
So, while it’s nice to see some concrete financials, remember that it is just one piece of a much larger puzzle. You are responsible for driving your success at the end of the day.
How does the “average” unit or franchise location operate in terms of revenue and expenses?
Item 19 of the FDD may give you some insight here, but you will also need to consider that your earnings and costs will differ from other franchisees’.
Are you planning on expanding into multiple units? You could benefit from economies of scale if you choose to do so from the get-go or even if you decide to expand later on (provided your desired territory is available).
When comparing franchises, pay attention to who offers multi-unit deals if that’s something you can take advantage of.
Learn More About Running a Successful Franchise
The information contained in this article is just a small snippet of the franchising advice we’ve put together in Your Comprehensive Guide to Franchise Success. This guide will walk you through the entire process of investing in a franchise, from determining if franchising is right for you all the way through to your grand opening and beyond.
Get your copy now on Amazon and get started with your success story!
