What Do You Have To Know About Financial Statements?

Key Issues

Financial statements are basically scorecards detailing a company's profit and losses among other things.

What Financial Statements to Use

The financial statements used are the balance sheet for at least the last two years, a statement of earnings for the past three years, a statement of cash flow for the past three years and a statement of stockholders' equity. Financial statements should have been audited by an accountant and the accountant should provide notes that will provide explanations about the franchisor and its financial condition. Compare the financial statement with the disclosure document and other information you have obtained during your ‘Due diligence, you will get a clear picture of the financial security of the franchisor.

Get Statements

Look for the opinion letter from the auditors. See if the letter indicates any concern or issues that are on going. Look at the balance sheet to find the franchisor's net worth and if they can meet its obligations. Find out if the liquid assets are sufficient to meet its current obligations, especially the obligation to you.

Look at Earnings

A company may be profitable hand has improved earnings over the three years but you should look more closely at where it's getting its income. Perhaps most of the income is coming from franchise sales, if they are, you should verify that the locations generating those franchise fees are actually scheduled to open. Have the franchisor sold more franchises? Check the earnings from royalties and other continuing fees and see if they are increasing every year. If sales are not increasing and locations are not available to those who have paid franchise fees, there is a good indication that something may be amiss.

You should always ask the franchisor for a breakdown of the franchise fees. It is important that you see a progression of increasing revenue from royalties and other continuing sources of income.

Some franchisors will have no problem providing a breakdown to you, but if they don't you or your accountant should estimate that information by multiplying the franchise fee by the number of new locations in the system and adjusted for any changes in the deferred income from the balance sheet. That should give you an idea of the financial stability of the franchisor.

It is a good idea to work with an accountant or lawyer when examining a franchise business. You should have someone who understands the nuances of a franchisor's financial statements as much of the value in the assets of a franchisor don't necessarily appear on the balance sheet.