The Basics of Franchise Accounting
Updated: Jan 10, 2019
Are you thinking about owning your own business? You're in great company, with nearly 29 million U.S. small businesses in operation.
The best part? You don't have to start your business from scratch.
Owning a franchise -- and eventually owning multiple units or becoming a developer -- is an excellent way to increase your earnings and independence without having to start a business from zero.
Still, if you're just starting a franchise, there's a lot you need to know about franchise accounting before you even get started. Here's a rundown on the basics of franchise accounting that you need to be aware of.
Let's jump in!
Starting Franchisee Fees
As a franchisee, you'll own an individual business location, operating it under the specific guidelines that the franchisor establishes.
The franchisor is the party who owns the company and gives you the right to utilize its business products and model. As a result, you can grow your company faster, as the brand is recognizable.
As the franchisee, you'll typically have to pay a lump sum of money to the franchisor, as this covers the help you receive from the franchisor in starting your business.
For example, this fee enables you to use the company's operating systems, trademark, and name. It also covers startup costs such as renovations, equipment, and training.
When it comes to accounting, you can include the current value of your payment amount as an asset that is intangible on your balance sheet.
For instance, your starting franchise fee may be $40,000, and you expect the franchise to last 10 years. You can record this purchase by debiting "Franchise" by $40,000 and crediting "Cash" by $40,000.
Amortization of Initial Fees
When you deduct your starting fee from your tax return, you'll have to amortize it. Amortization is akin to depreciation but involves intangible assets -- for example, a trademark.
So, you can spread your fee's cost over several years -- for example, 15 years. You'll have to deduct the same monetary amount every year, so simply divide your fee amount by 15.If your franchise agreement doesn't last 15 years, the initial fee's amortization schedule will simply last the length of your contract.
Regular Franchisee Fees
Once you have started your franchise, you will likely have to pay your franchisor a percentage of your revenues. For instance, you might have to give up 20%. This total covers a variety of services, including ongoing training and legal advice.
Sometimes a business owner's regular franchise fee is a portion of your gross sales. In other situations, it is a portion of his or her net sales. Meanwhile, it's a flat amount in other situations.
As a franchisee, you'll have to pay this amount no matter the amount of revenue you have generated. You may have to pay your royalties on an annual, quarterly or monthly basis depending on your franchise agreement.
Amortization of Regular Fees
As with your initial fee, you can amortize your regular franchise fee.
To do this, you'll need to divide your regular fee by how long you expect your franchise to last. For instance, $40,000 divided by a total of 10 years gets you $4,000.
Then, "Franchise Fee Amortization" can be debited by $4,000 at year-end, and "Franchise" can be credited $4,000.
Franchisee Marketing Fees
Another important franchise accounting consideration is marketing fees.
Your franchisor might charge you a fee for marketing. In this situation, your payment will contribute to the franchisor's marketing fund and thus be used to purchase advertising materials for promoting the franchise's brand.
You must add your marketing fee, which is typically a sliver of your gross sales, to your balance sheet as well.
Although you may start out as a franchisee, you may strive to become a franchisor down the road -- and for good reason.
As a franchisor, you'll own all franchise locations, managing your brand's big picture. You decide which services and products will be sold. You also offer franchisees ongoing support and work on creating an efficient operating system.
However, to earn money as a franchisor, "substantial performance" is necessary. In other words, every aspect of your contract that involves paying you money has been fulfilled.
If a future service has not been completed yet, then you'll need to report the current value of the future earnings as revenue that has not been earned. Then, when substantial performance occurs, your unearned revenue will become earned revenue.
Debt is an especially important item to tackle as you enter the franchising world and begin to master franchise accounting.
A majority of franchisees begin with large amounts of debt due to the following costs:
prominent store locations and refits
wages for staff as they undergo training
After all, you accrue all of these costs before you ever earn that first cent.
Fortunately, a number of finance options exist today. In fact, your franchisor might have given you financing or guaranteed the loan you took out.
Just make sure that you remain flexible enough to refinance in the event that better options for paying off your debt emerge. In line with this, constantly go over your debt to see if lower-cost alternatives exist.
Finally, be sure to hire a qualified accounting service to help you to manage your books. In this way, you will know for sure what is flowing in and what is flowing out of your business. You need the right amount of cash flow for servicing your debt, covering your ongoing expenses and paying yourself in the years ahead. We offer our clients Cash Flow Forecasting in our app to help them manage their cash flow optimally.
How We Can Help with Franchise Accounting
We offer top-of-the-line benchmarked reporting and accounting for today's entrepreneurs.We take pride in our efficiency and accuracy in the tax accounting and accounting services we provide. We also place a strong focus on customer service and technology, with your success being our number-one priority.
Get in touch with us to find out more about franchise accounting and how we can help you to feel empowered when it comes to managing your finances long term.