Understanding Point of Cash Flow and Working Capital Requirements in Franchising

When it comes to starting a franchise, you know you’re going to need to have cash available to invest upfront. How much cash do you need and when can you start seeing some cash come into your business? Those are two of the most important considerations you’ll need to make.

Let’s take a closer look at the point of cash flow, the working capital requirements and why these are so important to understand.

The Point of Cash Flow

The real point here is not cash flow but positive cash flow. The positive cash flow from the business is enabling the “business” to settle monthly debts rather than using working capital.

Cash flow — at least positive cash flow — is the point at which your business is making more than it is spending. This is when your business can settle monthly debts with the money you bring in, rather than covering expenses using working capital.

This does not happen immediately. It may take months — sometimes longer — before you get out of the proverbial red.

Working Capital Requirements

Up until the point of positive cash flow, you’ll have to use working capital you’ve set aside to handle monthly obligations. Most franchises require that you set aside at least 6 months of working capital to handle your debts. Estimates might be that your business will get to positive cash flow after 6 months but, be aware it might take longer. All businesses are different.

Further, don’t forget to set aside funds to take care of your personal obligations. If you’ve changed careers you’re not going to have a salary coming in to handle your personal obligations. It’s essential that you have enough working capital to not only get your franchise off the ground but also keep it thriving until cash starts coming in more steadily. Some of the most common working capital requirements in franchising include:

• Deposits and monthly rent checks for your new location
• Marketing materials to spread the word about your new business
• Hiring costs to staff your franchise
• Inventory

Getting crystal clear on the working capital requirements in your franchise as well as “at home” financial obligations is vital before you make any investment decisions.

The Risks of Not Paying Attention to These Before You Start Your Franchise

Statistically, most business failures are due to lack of capital or lack of funding. The last thing you want to do is underestimate the amount of capital you’ll need to run your business.

When you meet with your franchisor, you want to get up close and personal with the financial requirements. Talk to the chief financial officer about the average point of positive cash flow and the amount of working capital you will need to get to that point.

As always, perhaps your best and most realistic advisory source for financial requirements are current franchisees. During the validation, ask current franchisees how long it took them to break even and reach positive cash flow. Get several estimates on how much working capital they set aside and if it was enough. You’ll get a good idea, especially if you talk to enough franchisees, of the real cost of doing business.

Further, share this information with your CPA and ask him to help you with your budget and financial statements.

Many new franchisees don’t compare the point of cash flow with the capital requirements. If you’re not aware of how much money you’ll need to pay on a monthly basis before you start generating cash flow, you won’t know how much cash you’ll need to have available to you.

This can make it extremely difficult to pay your personal bills. It’s one of the biggest reasons some franchisees struggle so much in the first few months.

Are You Financially Ready?

Buying a franchise is hugely rewarding but the beginning stages can be difficult. By doing your due diligence, you can position yourself for greater success as you get your new venture off the ground.