Franchise Accounting: The Key to Growth and Profitability of Franchise Business

Managing accounts in a franchise business may seem complex and cumbersome to you. As a franchise owner,  there are multiple aspects related to your franchise business and its accounting , such as expenses, taxes, revenue, and more that you’d be required to manage in an effective and efficient manner. 

If you’re wondering what franchise accounting is, what all is included in it, and how you can ensure its effective and accurate management, read this detailed guide. In this guide, you’ll be learning the basics of franchise accounting, its key glossary terms , and activities involved in it. 

Read on to discover the nitty-gritties of franchise accounting! 

Franchise Accounting - Back to basics

Franchise accounting involves tracking and analyzing financial data related to the business operations. This includes keeping track of revenue generated, expenses, assets, liabilities, and preparing financial reports on a timely basis, while ensuring compliance with tax regulations. For accounting operations and management, it’s imperative that it’s managed by an accounts professional who holds relevant experience in franchise accounting. This is because, franchise businesses have a few unique fees, expenses, and rules that aren't present in non-franchise businesses, which sometimes make it difficult for accountants to create statements. 

Glossary terms for franchise business accounting 

When it comes to franchise accounting, it’s critical to understand key accounting terms to avoid errors and discrepancies in financial statements. Some common accounting glossary terms and concepts to know include: 

• Franchisee: A person or business that purchases the franchise operating right from a franchisor.
  
• Franchisor: A person or company that sells the operating rights, along with the brand, products, and services associated with it.
  
• Royalty fees: An amount to be paid by franchisee to the franchisor for the right to use the name, products, and services of a franchise business.
  
• Initial fees: One-time payment to be made by franchisees to the franchisor for training, site selection, and other establishment costs.
  
• Amortization: The process of spreading out the cost of a loan or an asset over a period of time.
  
• Franchise disclosure document: A legal document provided by the franchisors to the prospective franchisees, outlining the terms and conditions of the franchise agreement.
  
• Financial reporting: The process to compile and analyze a franchise business’ financial information, typically using an accounting software.
  
• Tax compliance: The process of adhering to the tax requirements for franchise businesses, including paying taxes, filing tax returns, etc.
  
• GAAP: Generally accepted accounting principles (GAAP) refer to a set of accounting standards, rules, and procedures that are issued by the accounting standards boards, FASB (Financial Accounting Standards Board).
  
• Cash flow: Total cash a franchise business generates versus the cash it expends in a given period of time.
  
• COGS: In franchise accounting, COGS (Cost of Goods Sold) refers to the money spent on raw materials to make the products, and appears on a business’ income statement.
  
• Prime cost: It refers to the sum of COGS and labor costs and is known to be one of the crucial metrics in franchise accounting.
  
• Revenue: It’s the total amount of money brought in through sales. For franchisees, revenue comes from selling the products or services, whereas for franchisors, it comes through royalty fees paid by a franchisee. 

Key components of franchise accounting records 

The accounting records of a franchise business plays an integral part in managing its financial health, making informed decisions, and complying with accounting and tax regulations. They also help to track the franchise development and growth over a given period of time. When it comes to maintaining accounting records, there are four key components that franchise accounting records must include: 

a.) Assets: All the tangible and intangible resources owned by your franchise business are considered as assets. These may include property, equipment, inventory, cash, and intellectual property. 

b.) Liabilities: All the debts and obligations that your business owns such as loans, taxes owed, and accounts payable are the liabilities. 

c.) Equity: This represents the value or percentage of your business that’s owned by the shareholders like investors, partners, etc. It’s calculated as the difference between the assets and liabilities of your franchise business. 

‍d.) Revenue/ Expenses: All the income and expenses of your franchise business such as sales amount, operating cost, etc., that you need to incur to run your business are the revenue/expenses.

Various fees associated with owning a franchise business

Simply paying the initial franchise fee isn’t sufficient for starting a franchise business. When it comes to the total cost of starting and running a franchise business, it can range from a few thousand dollars to millions, depending on the entire franchise system. 

While the average costs of starting and running a franchise business is disclosed by the franchisor in the Franchise Disclosure Document, there are several other expenses and fees that you as a franchisee and your account specialists need to be aware of to avoid errors and ensure seamless franchise accounting management. Some of the common franchise costs include: 

• Initial fees

If you’re planning to invest in a franchise business, then you’re required to pay an upfront fee to the franchisor to start your franchise location. While some people hold a misconception that the initial fee typically covers the startup costs, it’s actually paid only to purchase the right to use the brand name of a franchise business, its branding, and other similar assets. In simple terms, the initial fee is just like a membership fee to be paid by a franchisee to the franchisor. According to Frankart Global, over 50% of franchise businesses in the US require an initial investment of about $250,000. 

• Amortization of initial fees

In the majority of cases, franchisees typically have the option to pay off the initial fee over time or take any other loan to make the payment. This is referred to as amortization of the initial fee. If you’re going to own an already established franchise business, then as a franchisee, you’ll need to keep track of monthly fees until they’re entirely paid off. 

• Royalty fees

In a franchise business, a royalty fee is a recurring payment that a franchisee pays to the franchisor in exchange for the rights to use their brand name, products, services, and intellectual property. On average, the royalty fee can range between 3% and 6% of monthly gross merchandise value (GMV). This percentage may vary from brand to brand based on factors like the franchise’s size, industry, and location. For example, McDonald’s, the largest QSR chain, charges 4% of the gross sales from franchisees against the branding and intellectual property rights.. Whereas, Subway, an American multinational fast food restaurant franchise charges 8% of weekly gross sales as royalty fee from its franchisees.

• Marketing fees

Like royalty fees, marketing fees in a franchise business are the payments a franchisee pays to the franchisor as a fund for the marketing and promotional campaigns that benefit the entire franchise business. This fee is typically a percentage of the gross sales of a franchise unit used by the franchise brand for the creation of new marketing materials. In addition, the fund is used to promote brands through initiatives such as website development and updates, logo redesigns, advertising, etc. The ultimate objective of marketing fees is to help the entire franchise system to promote brand’s each franchise location and drive business by attracting new customers. 

• Technology fees

A technology fee in franchise business is a recurring charge that franchisees are required to pay to their franchisors to cover the cost of software, hardware, and other technology tools to support overall restaurant operations. Furthermore, this fee may also cover costs associated with training franchisees on the use of technologies and providing them with the ongoing support and updates. For example, Pizza Hut, a multinational restaurant chain, charges an yearly fee of $2,500 for technology and $1,500 for software training in addition to travel and accommodation expenses. 

The purpose of the technology fee is to ensure that franchisees have access to the latest and most efficient technology solutions which can help them to run their business in a smooth, efficient, and effective manner. In addition, it also ensures operational consistency across all franchise locations.

If you're running a franchise business or planning to invest in one, it's crucial to hire an accounting specialist experienced in managing franchise accounting. They should understand all aspects and activities involved in franchise accounting as even a minor error can severely affect your business' profits.

Activities under the umbrella of franchise accounting 

When it comes to franchise accounting, there’s a wide array of activities involved and these include:

1. Accounts payable processing

It’s the process of managing and keeping a record of a business’ outstanding bills and invoices, ensuring that the payments made to the vendor are accurate and on time. In addition, it also includes payroll to check if the employees are receiving their salaries on time with no discrepancies. 

2. Bank reconciliations 

This activity ensures the accuracy and completeness of all transactions and financial records, and identifies any errors in the financial statements that need to be corrected. 

For example, if your franchise business’ bank account has a monthly closing balance of $10,000, but your records show a balance of $9,000, then to reconcile the two balances, your accountant will compare the bank statement to the accounting records, and make adjustments as required. 

3. Business tax processing

This activity involves managing the tax obligations of your business that includes preparing, filing, and paying taxes to the relevant authorities. When it comes to business tax, it includes federal, state, and local taxes like income tax, property tax, sales tax, and more.

4. Cash deposit and credit card verification 

Cash deposit and credit card verification are important aspects of financial management in a franchise business. While cash deposit involves counting and reconciling the cash against sales records, preparing deposit slips, and depositing cash into the franchise’s bank account, credit card verification involves verifying the card’s validity and authenticity by reviewing transaction records. 

5. Expenses and loan accounting validation

By performing this accounting activity of franchise business, it becomes easier for accountant and franchisor to validate the amount of loan payments and other expenses. 

6. Financial statement processing

This activity involves the preparation of business’ financial statements on a monthly, quarterly, or annual basis. 

7. Fixed asset accounting 

This activity refers to the accounting for assets that are fixed and can’t be converted into cash, such as building, land, equipment, etc. 

8. Operations reporting

The preparation of operations report involves analyzing daily operations of your franchise business to determine inefficiencies and operational areas that need improvement. 

Quick tips to manage franchise accounting 

Managing franchise accounting is crucial for the success of any franchise business. By following the right steps and proper accounting practices help franchise owners keep a regular check on their finances, determine the areas of growth, and make informed business decisions. If you run a franchise business and find it challenging to manage your finances and accounting, below are the tips that will help you to ensure the financial stability of your franchise business. 

1. Develop a comprehensive accounting plan 

Curating an accounting plan that takes into account all the revenue streams and expenses associated with running your franchise business is the first step to ensure accurate franchise accounting and management. This will not only track your finances, but will also enable you to identify areas for improvement and make informed business decisions. 

2. Leverage accounting software 

Choosing the right accounting software that’s scalable, user friendly, cost effective, and easy to integrate with other systems like POS (point of sale) systems can help you track all your financial transactions and performance metrics in real time, generate detailed financial reports, and effectively manage accounts payable and receivables. Leveraging accounting software, you’re enabled to automate and streamline your franchise business’ accounting processes while saving a lot of time and effort by reducing manual data entry.

3. Monitor financial statements 

Regularly monitoring and reviewing the financial statements of your franchise business such as income statements, cash flow statements, and balance statements to keep track of the financial health of your franchise business. 

4. Manage accounts payable and receivables 

Keep track of accounts payables and receivables, which are key to the state of your cash flow, to ensure timely payments and collections. Make sure money owed to you (receivables) is coming in on time and that you have a system in place to deal with payment delays. In addition, while figuring out your payables, make sure you’re missing any important costs. 

5. Get a professional accountant on board

Consider hiring a professional accountant who comes with years of experience in franchise accounting and can help you manage finances of your franchise business. By getting an immensely trained and experienced accountant onboard will take the financial management burden off your shoulders and achieve effectiveness in financial reporting of your franchise business while ensuring compliance with regulatory rules and regulations. 

Wrapping it up

For any franchise business, accounting plays a critical role in franchise development and growth. From this comprehensive guide, it’s crystal clear that franchise accounting can lead to increased profitability and growth of franchise business. Given that it not only allows franchisors to determine the financial viability of new franchise locations, but it also helps franchisees to manage their finances effectively, it’s imperative that as a franchise business owner must do it right from the beginning itself to ensure your business runs seamlessly and drives maximum revenue and profits.