Franchise Math 101: ROI, Margins, and Break-Even Explained Franchise Fridays with Jeff Dudan #188

Welcome, everybody. Jeff Duden here. And welcome back to Franchise Fridays. And today we're going to talk about something very few people understand when they are actually at the point of investing in a franchise system. But everybody should. If you are thinking about joining a franchise system or if you've already signed that agreement, this might be the most important episode for you. Here's the deal. 65% of small business owners admit they don't fully understand the financial model of their business before they started it. Business is really just two things. It's people and it's math. And you've got to get the people right and you've got to get the math tight. That stat comes from Guidant Financial and it tracks because here's what I've seen over decades in franchising. People get sold on the brand, they fall in love with it, and they decide it's something they want to do or it's the people they want to do it with. But they don't always understand the math behind the model and it makes a difference. It's absolutely critical that you know what you're getting into. So today I'm going to pull back the curtain and I'm walking through what I call the hidden math of buying a franchise. It shouldn't be hidden. Actually, it's pretty basic. If you don't know it, it's been hidden from you. And it should be something that people do from day one, understanding the mechanics of a profit and loss and a balance sheet. But it's not always the obvious stuff. And if you haven't been a business owner before, it can be complicated. You got to put the time in and you need to focus and invest that time in making sure you understand it. It's not just the startup costs and the royalty fees that you saw in your fdd, but the ongoing stuff, the real stuff. How you figure out profitability and how you drive profitability. What is break even? How is it defined? When does it matter? And how long is it going to take for you to hit these key financial milestones that are so important for business owners to understand, especially during that startup phase. If you want to stick with me to the end, I'll show you how Homefront Brands is flipping the script and what it means to be profitable and supported as a franchisee. Now, let's get you unemployed in the very best way possible. First, understand your roi, your return on investment. I could also say it's a return on intention. How intentional are you about making money? And how intentional are you about understanding the Math of your business. When people think about roi, they often picture just top line revenue. How much will I get back and when will I get it back? But the truth is, top line means nothing without profit margins. It's really about what flows to the bottom line that matters the most. That's where all the calculations for what we're talking about really start. It's what you keep after royalties, after marketing expenses, after salary, inventory and cost of goods sold, and overhead. All of those things matter and you've got to know how to calculate them appropriately. So let's talk about margin, profit margin, gross profit margin first, and then we'll talk about net margin. Fundamentally, what are the gross margins of this business? Meaning after you pay the cost of customer acquisition, how much it costs to acquire a customer, and the cost of supplies, inventory, any products that go into the job or into the project, and your cost of labor to deliver and install, what is your gross margin after the cost to acquire the customer and deliver the service? That's an important number because that's basically what you have to work with to run the rest of your business. What we call the middle of the financial statement, the guts of the P and L. That's where your money comes in as an owner. That's where your insurance is paid for your rent, your truck payments, your gas. All of the overhead items have to be serviced by the gross margin. It just makes sense. If you have more gross margin, then you have more money to pay the middle of your P and L and thus more money flowing through to the bottom line, which is your net margin. Next, your break even. How much revenue do I have to do at that margin profile? That's what we're calling it, your gross margin profile of the business. How much revenue do I need to do so that on my bottom line it's zero, meaning I didn't have to put any money into the business and, and all of the costs, expenses of the business were covered by the business itself. That's an important number to know because then at a minimum every month by your top line, you have an indication of whether you are making money or losing money. And you can set your goals that way. Then beginning with the end in mind, it's about this owner's benefit because we're talking about franchise businesses and we're talking about small businesses. I'm going to use owner's benefit instead of net profit. Because your owner's benefit is everything that you benefit from being an owner of that business. Yes, it's going to include your net Profit, of course, but then you need to add back your salary, your benefits. If you get a benefit of putting a vehicle in the business that the business is paying for, you're not having to pay for it personally. Now, I would never suggest you do this for all of you IRS people out there, but let's say you have your kids, cell phones in the business because they occasionally work inside of the business, or you need to get in touch with them for those very important work things when they're on recess break at the middle school. All of those expenses are what, a benefit to you, Things that you would otherwise have to pay, all of these different things, everything that you benefit from in the business in terms of covering expenses, that's generally what we call owner's benefit and that's what you get out of the business. You gotta have a top line because without income there is no outcome. But understanding these margins, that's the first fundamental piece. Now you can start to calculate number two, which is how long is it going to take? What's my time investment going to be? What's my timeline to break even? What's my timeline to profitability? What's my timeline to getting the owner's benefit goal that I describe? Time is your most valuable asset. Not only how much time it takes in terms of chronological time to run through these steps, but how much time you're needing to invest in the business yourself. You also have to take that into consideration based on what you're getting. People get excited by the dream of freedom, but they often underestimate the ramp up and how long it's going to take to have money coming out of the business. After the business is servicing all of its debts to contribute to their household, you need to make sure if you're getting into a franchise opportunity that you're considering how much money you need to live out of the business and when you need to start taking that money. It's all part of that math equation. Even great operators with strong backing, it takes time. Of course it's going to take time to ramp up a business until you become cash flow positive. You're going to have an upfront investment, you're going to be negative in cash. You might have financed the business. Now you've got a debt payment. You're not going to have all of that debt up front. You're not going to be cash flow negative up front. But every month, whatever your payment is on that debt, you've got to put in the middle of your financial statement, in the guts to make sure that the business is servicing that debt and you're not having to put money in the business to pay for it. Now, once you overcome your upfront costs, how long is it going to take to get break even? When will the business be fully standing on its own? How long is that going to take? Then from the owner's pay perspective and the owner's benefit perspective, what's the expectation? Let's say you borrowed that money to start the business from an investor, not an institution, and they said you don't have to pay them anything right away. Maybe they're going to accrue their interest. How long until you take money out as as an owner? And then when did those investors start getting their distributions and recovering their cost of capital? Also, what's the monthly run rate once the business is up and generating consistent income? Are you satisfied with it? Are you willing to invest the time, energy and money to increase it? Or are you happy with the normal run rate of that business? And when do you want to just pay off your debt, stop paying interest to investors or banks, and start keeping everything that the business generates? So these are all important questions and you have strategy depending on what your risk tolerance are and your cost of capital is that you need to consider as you're planning, doing the math for the business that you're getting into. This startup curve has multiple steps. Number one, upfront investment. Number two, your time to first dollar. Number three, your time to break even number and then number four, your time to distributions. You need to understand, based on the margin profile of the business, how long each of this is likely to take and can you tolerate it? Franchisees fail when the business takes longer than expected to start producing and they start pulling money from the marketing budget to live. That's what I call the death spiral. If you stop driving leads and work in the top of the funnel, what's leaking out the bottom is going to dry up. Pick. So you need to make sure you're properly capitalized and you have some cushion in there and that you understand those points. And just don't just look at cost, look at leverage. In franchising, you get leverage in terms of speed to market, in terms of existing brand, in terms of existing tools, vendors, marketing plans. You're not building everything from scratch, but you still have to generate the revenue. Ask yourself, how does your franchisor participate in customer acquisition, in national accounts, in evolving the technology which is rapidly changing today with AI, those are things that you don't have to spend money on, but yet you benefit from them. And that's leverage. You're buying that infrastructure and that leverage will help you have a foundation and an infrastructure on which you can scale. When I evaluate a franchise investment, I look at three things really. @ the top of the house, the margin profile. Is there enough gross margin to service the middle of the P and L and to generate bottom line profit? What does that look like in a. In a good and better and best scenario? Number two, the time to the roi. What's the return timeline? In retail franchises with leases and build outs, it's often a 30 month time frame for a return on the original investment that private equity companies and banks are looking for. So if you're working in the business, you should take a market rate salary and that's fine. That doesn't really count on your roi, but ROI includes repaying your investment, any debt and any opportunity cost of that capital if you yourself were the investor. And number three, what's the revenue profile of the business? Where is the money coming from? Where is the revenue coming from? Is there a big enough customer set in your market for you to win? Is it a growing marketplace? Is there a compound annual growth rate that so that you can win customers without having to take customers from other competitors because there are more customers every year? What's the average ticket size, which would tell you how many customers do you need to reach your revenue goal and then ultimately to reach your owner's benefit or your income goal? And is there concentration risk? In home services, you might have thousands of customers every year. In B2B, maybe you've got 30 or 40. That might mean better retention and recurring revenue, but also a bigger exposure if you happen to lose a key customer. So and talking about recurring revenue, how much is recurring? How many times can you return to the same customer? Can you expand their wallet through upsells like membership fees, product services? That's the revenue profile. Understand how stable that revenue is. How much pressure will you be under to keep acquiring new customers month after month, year after year? And you want to make sure your effort today will make you money tomorrow. Franchise success isn't just about storefronts or logos. It's about the math behind the model. You want sustainable and you want attainable over sexy if the model's not proven or not sustainable or at risk of becoming obsolete. Most importantly, you need to be careful. Can you grow with more trucks, not just more square footage? Can you grow and charge for expertise, not just the products? Can you continue to elevate your price and price high and prosperity? And can you keep growing as you continue to increase and notch up your price to create more margin for you. If the answer is yes, you found a model that can scale, survive market shifts and deliver long term value. And that's what we're building at Homefront Brand. So if franchising sounds exciting, great. But don't skip the numbers piece. Don't just fall in love with the people or the product or the sexy. Make sure that the math works for you and the situation that you're in and the resources that you have available. It's not just a lifestyle decision, it's about not having something cool to tell people about. It's a math problem and a people problem and you have to solve both of them. The math doesn't work. The business probably won't either. If this episode helped you see franchising in a new light, or maybe help you think about where you should go and what you should do, share it with somebody who needs to hear it. Hit the subscribe Tune in every Friday for Franchise Friday, and if you're ready to explore franchises built for real ROI and real freedom, click the link in the description below. I believe it's going to be a Homefront Brands link. Who knows? Grab a free copy of my book Discernment while you're there. If you're at an inflection point, it will help you use decision filters to make the best decision possible for you right now in your life. And as always, check out homefrontbrands.com to see what we're building and whether it's a fit for you. Until next time, I'm Jeff Duden. Stay sharp, stay focused, stay unemployable, and let's get you unemployed in the best way possible. Thanks for listening.