It might be hard to believe but the Global Financial Crisis (GFC) need not be seen as all doom and gloom... it all depends on your perspective. Here, Christopher Brown explores how retailers and franchisors can draw inspiration from the banks to improve their position.

What the banks can teach us

In the midst, and in the wake, of the Global Financial Crisis (GFC), banks right around the world increased regulations and tightened lending. By becoming more selective and more risk averse, banks opted for quality clients over quantity, even though it meant losses in sales volume. In effect, the banks rigorously ensured applicants met all lending criteria and, as a result, were able to set the ‘good' businesses apart from the rest.

Following the banks' lead

Retailers and franchisors can similarly protect their interests by following the banks' lead and mimicking their refined regulations. For franchisors, this means a stricter review and approval process that includes assessing the franchise location as a standalone business, the franchisee's strength and sophistication, any accreditation or qualifications, and their CV.

By improving retail and franchisee selection criteria, the strength of both the franchisor and franchisees will improve. With defaults on debt and the winding up of sites having an impact on revenue and on the reputation of the franchise system, in this climate it can pay to be as conservative as the banks.

Historically, franchisors have been attracted by the potential of a new sale, and the opening of a new site, just as banks once focused heavily on writing new loans. Typically, franchisors were not as discerning as they could or should be of the franchisee in their eagerness to grow the franchise. This is not really surprising given the limited ability and systems franchisors generally have available to monitor and manage their sites. But can you imagine a bank lending to a franchisee based only on the revenue they generate?

Instead, to approve a loan or facility, banks require:

• A business case
• A statement of the franchisee's assets and liabilities
• Projected spends for capital expenditure and fit outs
• Working capital
• A review of the identified site and area demographics
• Agreements between shareholders and related party loans (if any)

There are some franchisors that have already adapted their own processes to include such rigorous checks and balances. Indeed, some go further, asking potential franchisors to complete psychometric tests and interviews with business development managers, peer groups and even the CEO.

Digging deeply: covenants and criteria

More often than not, banks evaluate a potential borrower's ability to service a debt - principle and interest costs separately as well as together - as well as recoverable values of assets, should a fire sale be required. Reporting frequency requirements generally increase with risk, but is usually quarterly or annually.

Crucially, a franchisee's credit rating affects how the banks manage their relationships with a particular franchise system, so it is important that franchisors incorporate the measures put in place by the bank into their monthly or quarterly reviews. This ensures that problem franchisees are identified and quickly corrected before any significant problems arise.

Serious about reporting

To review a facility, banks request a full profit and loss statement (P&L) and balance sheet. And although some franchisors request (and pray) for more, most only demand sales via a limited view of the P&L. Franchisors really need to ask themselves, why is there such a difference between themselves and the banks?

Additionally, in the past, franchisors have only been concerned with royalty fees rather than the long term viability of the franchisee. From our experience, systems are needed to track more than just the typical key metrics to, at least, address some of the following:

• Wages to Sales
• Sales/Square Metre
• Contribution Margin
• Inventory Days
• Accounts Payable Days
• Tax Portal Status
• Net Profit after owners' salaries
• Cash flow
• Rent to Sales
• Interest Coverage
• Notional Debt Servicing

For the best results, franchisors must review a franchisee regularly from three perspectives:  profit and loss, balance sheet and credit risk.

Get stronger, today

Not only are stronger and more sophisticated franchisors redefining the franchisee management process, they are also improving franchisee and site selection. To build a strong and sustainable franchise - especially in the current economic climate - the system needs to attract and retain franchisees aligned to the brand and the brand's strategy, while fostering a culture of transparency. 

Business Development Managers need to be equipped with tools to quickly and effectively review, manage and monitor franchisees, with additional business acumen training and development allowing them to be business advisors, not just watchdogs.

For more information on how to build a stronger retail or franchise system, contact Christopher Brown on 07 3233 3447 or email Christopher.brown@crowehorwath.com.au