As a franchise owner, you can run your own business without the risk of starting a brand-new company. Like any business, you take on the many responsibilities of day-to-day operations, including some basic accounting tasks. Though franchise accounting is similar to accounting for other types of businesses, it includes a few extra steps.
Each franchise location is owned by an individual. But, the entire franchise is run by a larger company. For example, someone in your town could own and operate a local fast-food restaurant. But the entire restaurant brand is owned by one, superior entity.
Franchising helps market a brand to a large number of customers. The brand already has an established customer base. When someone buys a franchised business, they already know that there’s a strong demand for their products or services.
Franchises consist of franchisors and franchisees. Both parties have different roles in operating the company. They should sign a franchise contract before starting a business together.
The franchisor owns all the franchise locations. They manage the big picture of the brand. The franchisor makes decisions about which products and services are sold. They also form an operating system and provide ongoing support to the franchise.
The franchisor needs individuals to operate each franchise location. For each location, the franchisor sells the rights to the franchise to individuals.
In franchise accounting, the franchisee owns an individual franchise location. They operate the franchise under the guidelines the franchisor sets. Buying a franchise can help you grow your business faster because of the recognizable brand. But, you don’t get to make decisions about the business.
Fees and franchise accounting
To own a franchise, the franchisee must pay the franchisor certain fees. The fees allow the franchisee to own the rights to the business’s brand, products, and services. The franchisor must make every fee known to the franchisee.
The franchisee pays an initial fee, which is like an entry charge to the franchise. To stay in the franchise, the franchisee pays an ongoing royalty fee. Sometimes, the franchisee pays additional fees.
The initial fee gives the franchisee the right to operate under the company’s name, trademark, and operating systems. The fee also pays for training, equipment, renovations, and any other start-up costs to open the franchise.
The franchisee pays the fee up front as a lump sum. Before paying the fee, the franchisee needs to project how much business capital they will need.
Amortizing initial fees
The franchisee can deduct the initial fee from their business tax return. The franchisee must amortize the fee. Amortization is like depreciation, but it deals with intangible assets (e.g., a trademark). The cost of the fee is spread out over a number of years during the useful life of intangible assets.
A franchisee can amortize the initial fee over 15 years. The same amount must be deducted each year, so the fee needs to be divided evenly. To do this, you would divide the initial fee by 15. If your agreement lasts less than 15 years, your amortization schedule for the fee will just last the contract’s length.
Once operating, the franchisee pays royalties each month, quarter, or year. Usually, the fee is a percentage of the gross sales. Sometimes, the fee is a percentage of the net sales or a flat dollar amount.
Franchisors earn their income through royalty fees. The fees also help pay for the franchise’s fixed costs. The franchisee must pay the royalty fee no matter how much revenue they generate, unless specified otherwise in the franchise agreement.
Some franchisors charge a marketing fee. The franchisee contributes to a marketing fund. The fee is often a small percentage of the gross sales. The franchisor uses the marketing fund for advertising materials that promote the entire franchise’s brand.
Accounting for franchises
Franchisors and franchisees need to understand franchise accounting basics. A mistake in transaction records could result in the franchisee or the franchisor being paid incorrectly.
Using online accounting can help franchise owners and franchisors communicate about the business’s finances. They can access the software program from anywhere with an Internet connection so that both parties have instant access to financial records. Using a single software provider for accounting and payroll for franchises could also lead to a volume discount for these services. Even if you decide to outsource your books to an accountant, payroll software for accountants could drastically decrease the financial burden on your overhead.
Do you need a simple way to track records for your small business? Patriot’s small business accounting software is made to make your life easier. Try it for free today!
This article is updated from its original publication date of March 18, 2016.This is not intended as legal advice; for more information, please click here.