When it comes to selecting the right franchise opportunity that is ideal for you and your family, there are thousands of options to consider. Attempting to narrow the selection process frequently comes down to the size of the initial investment, the financing options, the on-going fees and the anticipated return – what the Federal Trade Commission (FTC) refers to as a Financial Performance Representation.
While every franchise company must submit their Franchise Disclosure Document (FDD) for approval each year to the FTC, not all franchisors provide Financial Performance Representations. Within the FDD, these historic revenue representations are listed as an Item 19 and they can presented in a number of different ways. And one of the biggest challenges franchise companies face is to gather this financial data from all franchisees and provide an accurate representation of what new franchisees might expect in terms of sales, revenues or profits in the future.
In the brief interview below, recorded at the end of March 2022, Top 2 Bottom Business Solutions (T2B) discusses with Chris Kincade, CEO of the Janarus franchise, the challenges of collecting consistent accounting data and why it’s important to both the franchisor and their franchisees.
T2B: The first question that we have for you, Chris, is, have the FTC rules governing financial performance representations, which are Item 19s, changed in the last three to five years? If so, how?
Chris: What I’ve seen is that more and more people are using an Item 19 in their franchise disclosure, and it’s becoming more standard practice than we where 15 years ago. It was almost hit and miss – some did, some didn’t. People debated the merits of it. Now, I see it almost becoming standard across almost every vertical – prospective franchisees expect to see it.
T2B: Competitively, if you’ve got 10 or 20 or 40 other franchise opportunities offering similar products or services to yours, having an Item 19 and an Item 7 is really almost a must-have in 2022.
Chris: It is. I think you see certain industries are slower to adapt to that in certain verticals. In the commercial cleaning space, many people do not have an Item 19 in their disclosure. If they do, they have an Item 19 when they’re trying to sell master franchises, but not when they’re selling unit franchises.
T2B: Understood. In your opinion, why is consistent financial reporting for franchisees so important to the franchisor?
Chris: It becomes the foundation for being able to coach franchisees for success. You have to have a consistent set of numbers, so that you can see how they’re performing, learn from the people that are performing well. Also, disseminate that information to your franchisees across the system, so that if we’re all on the same chart of accounts and the same platforms, and I see someone that’s performing better than me in a certain area, I can reach out to ask them how they’re doing it. It’s also a way for the franchise system as a whole to learn from itself and improve. That you can take best practices across all of your franchisees and disseminate it across the board, but if you don’t have a consistent platform that you’re all using, then you don’t know if you’re comparing apples to apples.
T2B: Absolutely. You’ve really hit on my third question; what benefits do franchisees receive by participating and following a standard chart of accounts as provided by the franchisor? You’ve really just encapsulated that, which is, if you’re not all on the same page in terms of those numbers, then it’s hard to understand, as a franchisee, how you are doing compared to your peers.
Chris: It’s also part of why you invest into a franchise system, is for that consistency and not having to come up with and be an accountant, to create your own chart of accounts that you think best represents your business. As a new franchisee, you expect things to be turnkey. Creating a chart of accounts is not a value-add for you and what you need to do to run your business. Operating off of a proven method and using that data to learn from is one of the core functions of being part of a franchise system.
T2B: Not only is it not benefiting you (the franchisee), by creating your own chart of accounts, it’s actually a real hindrance because you’re cutting yourself off in terms of a good exchange of information with the franchise network that you’ve invested in.
Chris: I’m also, as part of this process, a firm believer in having one accounting firm that represents all the franchisees in a system because, you can have a standard chart of accounts, but if you have 20 different accounting firms inputting financial data into that chart of accounts, you’ll still have things getting classified differently, and so it still negatively impacts your ability to gain insight from the entire franchise organization.
T2B: Agreed. And that’s funny because that’s my final question – is just what you touched on. My last question is most franchises establish approved vendors for equipment, products and services: Do you have a suggested or recommended accounting agency for your franchisees?
Chris: Ours is beyond just a recommended agency. Ours is actually one of the requirements for our franchise.
T2B: That’s excellent. What haven’t we touched on that is important to franchisors and franchisees when it comes to accounting process and procedures these days?
Chris: I think some of it is even down to the process of how we go about coaching franchisees with the standard chart of accounts and many times, as the franchisor, we’re good at the product or service or whatever our widget is. We understand how we look at our financials to know if we’re performing well. But it’s a different thing to coach someone on their financial performance.
Looking at a standardization of a system so that you are able to rank all units, but to also share that data and to be a transparent franchise system because, so many times, one franchisee may excel in the revenue side of the business, another might excel in the customer experience, and yet another excels in the cost of goods sold. Each franchisee has something to learn from the others but if as a system, you can’t see each other’s performance, you don’t know where to go get the best information.
T2B: At that point, you’re not getting the full benefit of being a franchisee. You’re acting as a independent owner with little input from the outside and with little perspective on what your peers are accomplishing and what your business might be able to accomplish as well.
Chris: Let me add, I don’t think that it’s best used as something where it’s a stick that franchisors are trying to force franchisee compliance. It’s best used as a tool to coach financial performance and to coach people to be better within their business. There’s plenty of other mechanisms for ensuring brand compliance and making sure that the system is operating correctly.
A standard chart of accounts is really about the learning that can come and as you scale, the earlier you can adapt to having this process standardized, the better the history of data will be so that you can learn. When we had three units, we thought we were doing great with a top performer doing X. As we have 100 units and start to benchmark how fast you get to X, we realized that we were undershooting what the capacity for system to do.
The better benchmarking you can get, the better you can help coach the newest franchisee that comes on to say, “Okay, if you are hitting this milestone know that at you are on pace. If you’re struggling to get there, let’s figure out what’s going on because we know it is possible. We’ve seen it in 75% of the rest of the system.”
T2B: That makes a lot of sense. As we work with franchisors, clients of Top 2 Bottom, there’s frustration because what we’ve heard from them is that the FTC, over the last five years or so, has gotten very, very specific about what it takes to provide legal financial performance representations. It’s more challenging now than what it was before, according to our franchisor clients, so the need for consistent accounting, reporting is even greater.
If you are a franchisor, who A, wants to have an Item 19 to be competitive and grow your brand, and B, wants to show legitimate numbers from your current franchisees, you have no options. You really have to get that house in order.
Chris: I think one of the things with the Item 19 is there is still a lot of fluidity around what’s included, even though it has to be consistently disclosed. I think that there’s a need, from a franchise buyer looking at an Item 19, for there to be even more standardization to say – it’s not just the top 25% of your system or it’s an all or nothing. Not really all or nothing, but you’ve got to be able to give a broader swath of data because people need to understand both what top performance looks like, but also when a franchise unit is struggling, what does that look like.
Many times, these Item 19s, if you don’t read the detail of the footnotes, you can have a false impression of what the true performance of the franchise system is. There’s a need for just a greater level of detail, which fully requires everybody to be on the same chart of accounts and sharing that same information because many times Item 19s get created in a way where they only have half the system that’s on a standard chart of accounts anyway, and so they have to automatically limit they share to whatever that number is.
The more mature a franchise brand gets, the harder it is to get existing franchisees on to a standard chart of accounts, because people think that you’re trying to leverage that information for a variety of reasons. Many times, even if you have the best of intentions, once people have gotten used to doing something a certain way, it’s really hard to make that change.
T2B: Agreed. Many franchisors struggle with the reporting in terms of: Do we show everyone who’s following the right chart of accounts? Do we break it into – here’s every franchise from one to three years old and three to five years old and five years plus? Do we show by geography; here are major metro markets versus minor markets? There’s all these ways but if you don’t have all of your financial information together in the first place, it’s really hard to break that up into an Item 19 that’s actually useful for a prospective franchisee.
Chris: I think the more variation of all of those examples that you just gave, that we can create a system and in the Item 19, the better franchising will be overall. Because the last thing you want is for somebody to join your system and not have realistic expectations, and you not have realistic expectations.
To learn more about the accounting services that Top 2 Bottom Business Solutions provides to both franchisees and franchisors, please visit our T2B Franchise Accounting page today.