THE ROLE OF THE CHIEF FINANCIAL OFFICER THE ROLE OF THE CHIEF FINANCIAL OFFICER
By Andrew J. Sherman, Esq.

As a franchisor grows and matures, its management team must also evolve to meet new challenges and solve new problems. In the early stages, the management team of the franchisor is heavily focused on sales and marketing, which is often a necessary prerequisite to building a critical mass of franchisees. But as the emphasis shifts from franchise sales to service and support, additional personnel must be recruited in the areas of operations, administration and finance. Yes, finance. The management teams of many rapidly growing franchisors often lack experienced financial officers who can bring economic discipline to the organization. Effective financial management, reporting systems and analysis are the keys to the ongoing success of a growing franchise system.

When a franchisor reaches that critical stage of growth when it is necessary to hire a full-time financial officer, the first reaction is typically panic. First, because the position must be added to the overhead, and second, because they don't know where to start looking. Even the well-respected and well-recognized executive recruitment firms who specialize in franchising admit that there is a lack of truly qualified and experienced financial managers. Many franchisors have unsuccessfully recruited from the accounting profession - which can result in the placement of an individual who is very well-trained in the areas of accounting or tax planning, but may lack the operational experience to truly understand the special financial dynamics of the franchisor-franchisee relationship. The ideal candidate will have had some initial training as a certified public accountant but will also have had "hands on" experience as a CFO or comptroller of a franchise company, or at least with a firm that has a structure and method of distribution and growth similar to franchising such as dealerships, retailing or licensing.

The day-to-day job tasks of a well-rounded CFO typically include the following functions:

• Development of accounting and reporting systems
• Development of cash flow management programs
• Preparation of financial statements in satisfaction of federal and state franchise laws
• Financial analysis and forecasting for proposed new products and services to be offered by franchisor
• Development of capital formation strategies
• Initial and ongoing analysis of franchise and royalty fee structure
• Development of royalty and related fee collection and reporting systems
• Management of banking relationships
• Development of accounts payable and accounts receivable management programs
• Federal and state tax planning
• Review and critique of franchisee financial reports
• Development and implementation of operating controls and internal budgeting/reporting systems
• Analysis of vendor relations and cooperative buying programs
• Liaison to outside accounting firms and law firms
• Financial analysis of strategic plans and growth targets
• Analysis of proposed mergers and acquisitions, real estate development and international expansion
• Coordination of operations, marketing, management and other departments within the franchisor
• Review of travel budgets, trade shows and related promotional expenses

One of the continuing challenges of the Chief Financial Officer of the start-up and growing franchisor is to avoid the more common mistakes that harm or even destroy franchisors at various critical stages in their development. If you or your company have never made them, then try to avoid them. If it is too late, then try to learn from the mistakes and avoid making them again.

(a) Undercapitalization - Lack of operating capital is the kiss of death for many early-stage franchisors. Although franchising, as a method of business growth is less capital-intense that internal growth, a sufficient working capital reserve is still required for development and implementation of the franchising program as well as the ongoing costs of support.

(b) Cash Flow Mismanagement - Any time that the CFO needs to put pressure on the marketing staff to "close a deal so that we can pay rent this month," cash flow is being mismanaged. Not only is the company undercapitalized under such a scenario, but also cash flow is being misdirected and mismanaged. General operating expenses and support costs should be paid for with royalty income, not franchise sales. A "robbing Peter to pay Paul" approach will result in a compromise of franchise screening and qualification standards as well as create an undue financial burden on the company.

(c) Underestimation of the Costs of Ongoing Support and Service - Ask the average franchisor how they arrived at their prevailing royalty rate and they will answer "from our competitors!" Ask them how much it actually costs to support and service each franchisee and you will get a blank stare. The royalty rate must be a reflection of a detailed analysis of the costs of maintaining support systems for the franchisees, not a number picked from the air!

(d) Lack of Adequate Forecasting for the Performance of the Typical Franchisee - Regardless of whether or not your company chooses to provide earnings claims, the forecasting of the performance of a typical franchisee is a critical step in building a franchising program. The internal analysis of a typical franchisee's performance will help the franchisor determine the viability of the franchising program from the franchisee's prospective as well as help predict its own stream of royalty income on a per unit per annum basis.

(e) Underestimation of Marketing and Promotional Expenses - What is your cost per lead? What is your cost per award? Many early stage franchisors are unable to predict or measure their actual costs in generating leads, screening prospects and ultimately awarding the franchise to a qualified candidate. This may lead to an unpleasant surprise at the end of the quarter or fiscal year when you finally discover that franchises are being awarded at a loss or that marketing costs are running well beyond budget.

(f) Underbudgeting for Costs of Resolving Disputes with Franchisees - How much do you think it will cost to resolve a genuine dispute with a disgruntled franchisee? Take that number, triple it, and you are probably getting close. Litigation is costly, drawn-out and frustrating. The alternative dispute resolution techniques, such as arbitration and mediation may be more cost-effective, but still can be quite expensive. In building a franchise system, disputes with franchisees are inevitable, so it is best to begin building a "war chest" now so that a fight down the road does not unexpected cripple the company.

(g) Co-Mingling of Advertising Resources - Many early stage franchisors inadvertently co-mingle funds received by their franchisees into a national advertising fund (which is supposed to help build brand awareness and create more customers for all franchisees) with the funds which are set aside to conduct marketing efforts to attract more franchisees. These accounting errors are not only a breach of the franchise agreement but also create franchisee resentment, tax issues and accounting problems for the franchisor.

(h) Miscalculation of Projected Item VII Opening Expenses - Nobody likes unexpected financial surprises, especially not franchisees that are opening up a new franchised business. Your prospective franchisees will naturally rely heavily on the projected start-up costs included in Item VII of the UFOC in doing their own financial planning and capital formation. Yet, many early stage franchisors try to keep the total figures in Item VII as low as possible for marketing purposes on the theory that the lower the cost to open, the more franchisees they will be able to award. It is far better to be on the conservative side in projecting Item VII costs, allowing plenty of reserves for working capital. This will result in less disgruntled and unpleasantly surprised franchisees which will only serve to help marketing efforts over the long run.