You wouldn’t start a 5-mile run without warming up your muscles, investing in supportive shoes, and filling up a water bottle. So it surprises me how many new franchisees don’t put enough time in prepping for a successful sprint into the business world.
Financial models require as much, if not more, attention than other aspects of the business. Without a solid model, investments can come up short, requiring franchisees to pump an excess of their own money into the business. When operators don’t have the funds, they risk joining the 82 percent of failed businesses that fold due to cash flow problems.
It’s worth noting that there’s no substitute for a strong financial model when it comes to a new business venture. Don’t let the franchising world’s supposed 90 percent survival rate lull you into complacency. Instead, build a model that works like a map to keep your franchise on course, and make timely corrections as the business grows.
Common Financial Model Blunders
Even companies with the best intentions make the worst mistakes when building their models.
Here are common mistakes I’ve seen in my several decades in the business world: Some people forget to include all relevant revenue and expense lines, which can skew projections and lead to bad investments. Others overestimate revenue, counting on growth that might not happen. Still, some new franchisees fail to apply proper timing to different expense lines, lack an effective control sheet, forget to plan for various financial scenarios, and neglect to forecast the payback period.
Clearly, there are a lot of variables at play, and it’s easy to feel overwhelmed during the financial model creation process. However, with a methodical approach, you can keep your franchise on an accurate, realistic path toward success.
3 Tips to Maximize Your Financial Model
Effort, care, and detail — all three are essential in gearing up a well-rounded financial model. Here are three tips that I recommend any franchisee put into practice to check all those boxes:
- Ask questions until the answers make sense. Ask your franchisor as many clarifying questions as you need — and I really mean all of your questions. If it’s your first time creating a financial model, you can’t shy away from what you don’t know. Comb through your franchise disclosure document and take detailed notes. Pay special attention to item 19, which covers factors that can affect your future financial performance, including earnings and costs. These sections vary but should look similar to a collapsed version of a profit and loss statement.Also try reaching out to experienced operators and asking them questions. Some will be more willing than others to share the details of their models, but the more you ask, the more information you’ll receive. Find out which revenue and expense lines they include on their models, and ask which projections they got wrong in the beginning to avoid making the same mistakes.
- Build in a ‘fudge factor.’ No financial model can predict results with perfect accuracy. Whether it land below, above, or a mix of the two, don’t fret small inaccuracies in your model. You can learn to avoid unexpected expenses by planning for them; this mindset will help prevent you from relying too heavily on predicted numbers.Build some room into your model to cover unforeseen overhead, and provide opportunities to reinvest in unanticipated gains. Are you finding yourself unsure about certain line items or have a gut feeling that legal fees, for example, might run high one month? There’s no shame in averaging that cost up for some much-needed flex room.Nonetheless, keep your fudge factors practical. If you build in too much wiggle room, you could skew your outcomes. Be selective about the fudge items, and keep the general direction clear.
- Act quickly on good information. When your model is finished — fudge factor and all — it’s time to quickly set up your general ledger and profit and loss.Too often, business owners go through all the work of creating a financial model to test the viability of an investment, only to fail to follow through. The financial model is not the end of the road. Rather, it’s the first step toward setting up the profit and loss and tracking revenue and expenses. Some operators take as long as six months to set up their profit and loss statement, which leads to lost revenue and uncertain financial security.The longer you wait to log financial information, the more likely you will enter incomplete data. By doing this, you might lose expenses and misplace records. Don’t do all the legwork of running the business and then quit before the finish line; keep diligent records from the start so you can rest easy.
Creating a financial model is not for the faint of heart, but don’t get tied up in the mindset that you have to go at it alone. Network and connect with peers in the business you’re going into. You may be surprised at the feedback you receive when you bounce your models off seasoned operators. Remember, though: No model will ever be perfect. Overanalyzing data to the point of paralysis is almost as bad as having no model at all. Build your model, build your confidence, then take the leap toward success.