Franchise Investment: What is Working Capital?
Alice Tuffery, writer
Published at 30/01/2018, Updated on 04/05/2022 , Reading time: 5 min
The world of franchise finance can seem complicated, especially when you first start to consider investment opportunities. Most franchises tell you how much their franchisees spend on the initial fee, business set-up and ongoing costs - but you’ll need extra funds to keep you afloat. Here’s our franchise investment guide to working capital.
There’s a lot to think about when you first create a budget and business plan, so it’s easy to overlook working capital. You’ll want to secure your loan, launch your unit and welcome customers, but when you first start out, you probably won’t be able to earn enough to cover your expenses.
As a result, it’s vital you have some money saved to keep you ‘out of the red’ for the first few months.
What is working capital?
In accounting terms, working capital is the difference between current assets and current liabilities. Put simply, it’s the cash you need to maintain your business on an ongoing basis. Working capital shouldn’t be tied up in assets (such as property) as you’ll need to access it from the outset.
When you buy into a franchise, you will create a cash flow forecast to determine how much money you can expect to make and when you can expect to make it. Of course, your investment total may not cover ongoing payments and, even if it does, the figures you prepare may turn out to be unrealistic.
So, you’ll need to have additional cash available for times when your revenue doesn’t cover your expenses.
Why do you need working capital?
One of the most common reasons for franchise failure is financial miscalculations. Investors who underestimate the amount of money it will cost to bring their business to profitability or fail to do the necessary due diligence set themselves up for disaster.
If you don’t have enough working capital, you may end up closing your business even if it’s doing well and potentially even losing personal assets. Not only is this situation usually financially catastrophic, but it can also be emotionally and professionally damaging.
>> Read more:
- 4 Reasons Why Investing in a Franchise Is Worth It
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- To Invest in a Franchise or Start Your Own Business, That Is The Question.
- 10 Pros and Cons of Investing in an Established Franchise
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How do you generate money for working capital?
There are a few different ways to build up working capital for your franchise investment, including:
Personal savings - The safest way to finance working capital is through your own savings, putting aside enough to keep your business going without compromising on your quality of life.
Business overdraft - If you have an overdraft, you’re only charged interest when you use it, so you can dip into the extra funds whenever you need to without racking up huge fees. Also, you can set overdrafts at different values for greater flexibility.
Invoice financing - If you’ve been running your franchise business for a while and just need some extra cash to cover expenses, you could consider invoice financing. You sell outstanding invoices owed to you by clients to get immediate capital.
How do you calculate working capital?
Most franchisors ask investors to have at least six months of working capital available before buying into their franchise, but every business is different. You may achieve a positive cash flow within six months, or it could take significantly longer.
To find out how much money you’ll need, review cash flow forecasts and statements from existing franchisees in the network - ideally, people operating in territories similar to yours. Once you know roughly how long it took them to break even and start turning a profit, work out how much it would cost you to pay all your expenses for this time period.
When you calculate how much working capital you’ll need, you should take all your ongoing payments into account. Expenses vary, depending on the type of franchise you join, but the most common ones are:
Commercial property rental payments
Utility bills
Recruitment and training costs and staff salaries
Stock and equipment
Local marketing activity
Most investors calculate their franchise investment costs as part of a comprehensive business plan. Any individual or organisation considering lending you money will want to review this document and make sure you stand a good chance of turning a profit and repaying your loan. But even if you don’t need to approach any lenders, it’s worth making a business plan in order to analyse costs.
>> Read more:
- 4 Reasons Why Investing in a Franchise Is Worth It
- Thinking About Investing in a Franchise? Here's What You Should Keep Top of Mind
- To Invest in a Franchise or Start Your Own Business, That Is The Question.
- 10 Pros and Cons of Investing in an Established Franchise
- Making your mind up: Top 5 things to consider before you invest in a franchise
- Reasons why you should consider investing in a new franchise system
Getting more help with franchise investment calculations
Your franchisor should be a good source of information when calculating franchise investment costs, so don’t miss out on your chance to ask for advice. They’ll be able to provide accurate financial statements from existing franchise units and put you in touch with other franchisees for extra guidance.
We always recommend prospective franchisees make contact with existing ones. Not only will they be able to tell you whether the franchisor’s financial projections are realistic, but they’ll also give you an unbiased account of life within the business.
When you meet with franchisees, ask questions such as:
How long did it take you to achieve a return on investment?
Have you been able to reach the profit margins you’d imagined?
Were there any hidden costs you discovered after signing the franchise agreement?
More information on how to invest in a franchise
Becoming a franchisee can be a highly fulfilling career choice, but, as with any business, getting a franchise unit off the ground takes a bit of careful planning. By completing a thorough financial assessment as part of your due diligence process, you can give yourself the best possible chance of success, without the fear of being undercapitalised.
If you’re thinking about running your own business as part of a franchise brand, it’s important you get as much information as possible before you make your first moves. Our business guides cover a wide variety of topics across all aspects of entrepreneurship, and we have plenty of tips for new franchisees when it comes to franchise investment financing.
For a detailed look at the planning process, see our guides on building a budget and the steps you need to take to create one.
You may also be interested in our article on how to finance a franchise with a tiny budget.
You can find all these business guides and many more in our article catalogue. Alternatively, use the search box to find articles on particular topics.
Alice Tuffery, writer