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Decoding the Franchise Disclosure Document From A to Z – Item #21

Ah, financial statements. Your Franchise Disclosure Document wouldn’t be complete without them.

Straight and to the point, Item #21 is best reviewed with your accountant or CPA.

What you’ll find:

• Audited financial statements from the last 3 years, including

  • Balance Statements
  • Profit & Loss Statements, and
  • Other standard components of a business financial statement

Why is this important?

Financial statements are critical when you’re purchasing any type of business; particularly a franchise, though. Because it is a controlled environment and business model, you’ll have very little flexibility to switch things up. So, if the financial statements are looking bad, it’s a pretty good indication of what your own statements might look like, as well.

Again, the financial statements should always be reviewed with your accountant – preferably one with franchise experience or knowledge – so that they can accurately determine the franchises financial strength, stability and long-term sustainability. After all, that’s the whole point of looking at their statements. Your accountant should also be looking at things like the current ratio of assets to liabilities, recent bankruptcies (see Item #4) and deferred revenue. All of this information will tell you how well the franchise handles their money, where their ‘profits’ come from and other details about their financial IQ.

Red flags – there’s always a red flag. The biggest thing to look out for is a franchise that earns most of its profit from actual franchise sales. A stable franchise will make enough in royalties to stay afloat, because it’s a sign that their current locations are doing well and that investors are staying long-term. But, if franchise sales are their main source of income that means that the franchisee locations aren’t turning a big profit and the franchise is constantly looking for new investors so they can capitalize on the initial fees.

Additionally, while reviewing the financial statements, it’s best to compare them to Item #19 – which, if you recall – tells you what the current franchisees are actually earning. Remember, though, the franchise isn’t required to provide that information. So, if the financial statements are poor – and they have opted not to reveal their current franchisees earnings – then you should probably start asking some serious questions and proceed with caution.

The bottom line is that Item #21 will give you a broad picture of the franchises financial foundation. Are they solid or not?

Next week, we’ll wrap things up in our ‘Decoding the Franchise Disclosure Document’ series with contracts and receipts…