How to be Franchise Audit Ready

Nov 1, 2024 | Listen

Stacy Farber and Kathy Svetina discuss how to prepare for a franchise audit for your growing franchise business in the Help, My Business is Growing podcast.

Franchise audits are important for keeping your franchise business financially sound. They can help you avoid costly financial mistakes and maintain compliance. However, many new franchisors overlook this critical step and struggle with the process. So what’s involved in a franchise audit and how can it benefit your business?

Stacy Farber: Expert Insights on Franchise Audits

In this episode, Stacy Farber and I explore franchise auditing particularly its purpose, preparation, and process and how, when done right, it can positively impact your franchise business.



Timestamps for this week’s episode

04:20 What auditors look for in financial statements 

10:02 How revenue recognition affects your financials

25:54 Common issues in franchise audits

27:41 Best practices running a franchise  

34:03 Actionable tips to take to get  your business franchise audit ready


What franchise auditors look for in financial statements

When auditors look at financial statements, they start by checking the trial balance and asking for supporting documents including all the financial statements and even foundational papers like LLC organization documents and the Franchise Disclosure Document (FDD), which details all the franchise fees and other important information.

A key area that auditors will focus on is how you recognize your revenue. They review how initial franchise fees and royalties are recorded, as different methods can affect the financial statements. Getting this right from the beginning is crucial for accurate financial reporting and overall business health.

Auditors also pay close attention to the equity of the business to see if it has enough to keep going, a concept known as “going concern.” If your equity is in the negative, it’s a big warning sign about whether the business can survive.  This is particularly important for new franchises that might face early losses and not have enough capital. In these cases, auditors might need to add a note in their report to point out the financial risks, which could cause concern for investors and lenders

So as a business owner, you want to make sure you have good controls in place, basically over all of your financial records, but especially cash and journal entries.

How revenue recognition affects your financials

Revenue recognition is when your business officially counts money as earned or more accurately, when you’ve actually earned that payment. For most businesses, like manufacturers, it’s straightforward: once the product is shipped, the sale is earned and can be recorded as revenue, even if payment hasn’t been received yet.

But with franchising, it’s more complicated. The initial franchise fee might not be recognized until the franchise opens, because there are many steps involved, like finding a location and training staff. Some businesses simplify this by separating these steps so they can recognize revenue sooner. Royalties, on the other hand, are usually straightforward and are recognized weekly or monthly, depending on the type of franchise.

Getting revenue recognition right is important because it influences how your financial health looks to others, particularly to your investors, regulators, and other stakeholders.

“When you’re starting these businesses, you want to think about who you want reviewing and approving certain things, just to make sure that there’s a segregation of duties so one person isn’t doing everything.” – Stacy Farber

Common issues in franchise audits

Stacy shared that the most common issue in franchise audits is weak financial controls. As a franchise owner, it’s good to have a strong internal control process in place, especially when it comes to who is handling the cash and making journal entries.  

Make sure no single person is responsible for too many financial tasks. For example, the person paying the bills should not be the person making the deposits. When you have the right amount of layers or have multiple people involved will reduce the risk of errors and protect your business from potential fraud. It will also help you avoid serious financial setbacks and make the audit process much smoother.

It's always a good practice to do monthly reconciliation of your balance sheet accounts. That's where you're going to find issues if things are misclassified, misposted, or missing.

Best practices running a franchise

  • Build a strong team, including a lawyer to handle all the legal aspects, and an accountant to manage your daily finances and taxes.
  • Choose the right software being mindful of the size of your business. If it’s on a smaller scale, QuickBooks is a great option. But for larger-scale businesses, look into NetSuite among others for multiple locations and complex needs.
  • Regularly review your financial records and contracts to make sure they’re solid and up-to-date. 

“To find the right auditor, ask yourself: Do you like the person? Do you think you can have a relationship with them? Do you think you can trust them? Do you think they’re going to give you a good product? Do you think they’re going to be responsive?” – Stacy Farber

Actionable tips to get franchise audit ready

To get your franchise audit-ready, start by finding potential auditors. Search online and ask trusted advisors or franchise attorneys for recommendations.

Once you have some names, interview them and get their fee proposals. Choose someone you trust and feel comfortable with, and who is responsive. Building a good relationship with your auditor is key to a smooth audit process.

Summary

  • Auditors review your trial balance, financial documents and revenue recognition to assess the financial health of your business.

  • Revenue recognition is the practice of recording income when earned; For franchises, the initial fees are recognized when the franchise opens, while royalties are recorded regularly.

  • Prevent audit issues by separating financial tasks and who is responsible for them to reduce fraud.  

  • Best practices for running a franchise include building a strong team with a lawyer and accountant, choosing the right software, and keeping records updated.

  • The next actionable step to take to get franchise audit-ready is to find a competent and experienced auditor, be it online or through referrals and recommendations, and choose one you trust and feel comfortable with.

Transcript

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About guest – Stacy Farber, CPA

Stacy Farber brings over 25 years of experience in audit and financial leadership experience to her engagements and is the Connecticut Audit and Attest Practice Leader. She has extensive experience completing financial statement audits, single audits, and reviews and compilations for multiple industries, including franchising entities. She will be responsible for overseeing the audit engagement and communicating with management regularly to ensure service quality.

LinkedIn: https://www.linkedin.com/in/stacy-r-farber-cpa-9a3722/


About host – Kathy Svetina

Kathy Svetina is a Fractional CFO for growing small businesses with $10M+ in annual revenue.

Clients hire her when they’re unsure about what’s going on in their finances, are stressed out by making financial decisions, or need to structure their finances to keep up with their growth.

She solves their nagging money mysteries and builds a financial structure with a tailored financial strategy. That way they can grow in a financially healthy and sustainable way.

Kathy is based in Chicago, IL and works with clients all over the US.

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