Armanino Blog

The Importance of the “Red-Headed Stepchild”

In the franchise world the importance of timely and accurate financial reporting, and its impact on the success or failure of a franchise system, is rarely emphasized. It’s treated like the “red-headed step child.”

While the importance of the franchise business concept and marketing of it cannot be overstated, the success of a new franchise also depends on making sure the financial side of the business is set up properly. Both the franchisor and franchisee must work to make this part of their business function properly and recognize that they both have a significant stake in making this relationship work.

As a CPA, I have been performing accounting and auditing services for more years than I would like to admit. And one of the common ingredients I have seen in all successful companies is that they all have timely and accurate financial reporting that allows them to be able to make informed business decisions. Almost every business decision that is made on a daily basis has financial consequences. Most entrepreneurs go into business to make money (I don’t know of a single owner who went into business to lose money). That being said, these businesses have to have some mechanism to determine if they are making money or not.

Our significant hands-on experience with franchisors allows me to positively state that of all of the businesses and industries that I have worked with, the franchise industry has the most substandard financial reporting habits—especially early-stage franchise systems. In our opinion, it doesn’t have to be this way!

Find the Right Team
When a business owner makes the important decision to franchise their business, it is essential to make sure that they have the right team of advisors and consultants to help them set everything up properly. If properly guided, the new franchisor should expect to go through an extensive educational and training program provided by one of the people on their advisory team, so it is important that they find someone who can do this for them.

A new owner will also need to invest the time needed to produce and understand a franchise agreement and operations manual. There is also a need for sales training that will help the prospective franchisor understand how to sell individual franchises, multi-unit franchises and area development agreements. Make sure your team includes professionals who know how to help you to do this.

Franchising is a Regulated Industry
There will be significant effort and resources spent in developing the Franchise Disclosure Document (FDD) that must be filed within the state that the new business will be operating in. The FDD is the critical document in launching and renewing franchises. There are twenty-one items detailed in the FDD of which the franchisor must understand and be in compliance with.

The item that is the least discussed is Item 21, Financial Statements. You will need the right accounting firm to help you make sure that your financial statements are in compliance. Make sure the accounting firm you use has franchise experience.

Having worked with many newly emerging franchises I have seen firsthand that the one area rarely focused on during the preparation phase is financial accounting and reporting. To me this is doing a disservice to the franchisor and future franchisees.

If you were to survey franchisors, which we have done, the major pain point in the franchisor/franchisee relationship is financial reporting—or lack thereof. The franchisor wants timely reports from the franchisee so they can collect their royalties on a timely basis and evaluate the financial health of their franchisee family.

When the franchisor pushes for these reports the franchisee sometimes pushes back saying that they don’t have time because they’re consumed with running their business. This pain point is a direct result of the lack of training or providing an accounting and financial reporting solution to the franchisee.

To remove this pain point, it is important to establish the accounting and financial reporting system from the very beginning as part of the franchisee training process. Presently, this is not part of the required business planning and pre-FDD filing process, which leaves a huge void in the process of setting up a new franchise. If franchisors are going to have a better chance for success, the financial accounting and reporting training solution MUST be part of the pre-filing process.

The FDD preparation is done on an annual basis. The operations manual will only be modified for changes in the operations. The Franchise Agreement is done once and may be tweaked for changes from time-to-time.

The “red-headed step child” is the financial accounting and reporting needs of your business. This is the step child that cannot be ignored, it must be a daily endeavor and needs to be taken care of before (not after) starting a new franchise. Many decisions will hinge on how good the financial information is that a new business owner will base their decisions on. The fact that this process is ignored during the pre-launch process is not only bad business. It is just wrong.

The financial accounting and reporting needs must be brought into the planning and daily operations of a new franchise business. If this is done properly, it will give the entrepreneur the best chance to succeed.

October 25, 2013

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