COPING WITH COSTS

What do you know about wages, paying rent and cost of goods sold?

by Kate Groom, SmartFranchise

When considering a franchise, you need to look into the financial aspects. This means coming to grips with the financial language of business. Some terms may be familiar, but others will be new to you.

There are three key financial terms you need to become familiar with. For many franchisees, the three most significant costs in their business are wages, rent and the cost of goods sold. Together, these can eat up more than 60 cents of every dollar you make in revenue. By understanding what these costs involve, you will be in a better position to manage them and run your business well.

WAGES – AND MORE

Of course you know what wages are, having been paid for the work you have done yourself. Even so, there is a bit more to understanding this important category of costs than knowing that wages are what you pay your employees. For instance, what about superannuation? Is it part of wages?

Coming to grips with the financial language of business is part of taking up a franchise. What do you know about wages, paying rent

and cost of goods sold?

First, the big picture. Wages are made up of two costs: the wage or salary, plus compulsory superannuation contributions made by the employer.

For most franchises, it is best to split out costs between wages for employees and the money the owner draws from the business. This helps the owner see how much they are being paid. So, when we set up franchisee accounting we create two categories of wages: those for employees (staff wages) and those you pay yourself (owner’s wages, or drawings).

Superannuation, usually referred to as “super”, is money set aside over your lifetime to provide for your retirement. For most people, the employer must pay an amount equal to 9.5 per cent of their salary into their super fund account. This is on top of their salary or wages. Employer contributions are based on “ordinary time” earnings, such as commissions, shift loadings and allowances, but not overtime payments.

If this seems complicated, it is. The good news is that information is available online to help you. Two reliable sources are the Australian Taxation Office website, www.ato.gov.au, and ASIC Money Smart, www.moneysmart.gov.au. Also, your franchise accountant should be able to explain the basics and also set you up with payroll software that does many of the calculations for you.

There are two other factors that affect the wages cost in your franchise: 1. Most people who work in Australia are entitled to receive a specified minimum wage as set out in the government’s modern awards. As an employer, you are required to comply with these awards.

2. It is important to understand the distinctions between permanent fulltime, permanent part-time and casual employment. This includes knowing about holiday and other leave entitlements as well as extra pay (“casual loading”) which is an entitlement for casual employees.

The Fair Work Ombudsman’s website, www.fairwork.gov.au, has information about these aspects of employing people.

New franchisees often ask how much they should pay themselves. There is no single answer to this as it depends on a variety of factors including the financial position of the business, the franchisee’s personal financial situation and tax planning. However, when you are evaluating a franchise, it is important to consider whether the business will be able to provide you with a satisfactory wage.

Also when evaluating a franchise, it is essential to work out the true cost of employee wages. You should work out the monthly cost based on the hours the business is open and at least the minimum award wages for various staff roles (including your own time). Then consider whether the business will be able to afford these wages based on a realistic level of sales.

RENT, AND OTHER COSTS

Rent is what you pay to occupy the premises where you run the business. However, there is a little more to this than rent for an apartment or house. Here are three things to watch out for...

1. What is included in your rent? Check if there are any extra property-related costs on top of the rent. These might include such outgoings as marketing levies (in shopping centres), or the cost of electricity, gas or water. If the business is in a shopping centre, you may also face extra payments related to the value of your sales.

2. Plan for the end of your rent-free period. New businesses often receive a rent-free period at the start of their lease, but it can be a shock when the payments kick in. So when you are preparing your initial budget for the business, allow for the full monthly rent when you assess whether the business can make enough profit to satisfy you.

3. Be aware of rent increases. Your rent will rise each year, according to the terms of the lease. This means it is smart to add up the total cost of rent and check whether it would be reasonable given the sales you expect to make over the whole lease period. If you are buying an existing business and the lease is about to expire, be sure

A better approach is to think carefully about the right mix of staff members, blending experienced hands with juniors who are learning the ropes. At the same time, it can often pay to have fewer, more efficient and skilled staff than a bunch of less-competent

people hanging around.

to seek advice on the likely terms of a renewal. If the current rent is below market rates, you may face a big increase in costs on renewal.

COST OF GOODS SOLD

Cost of goods sold (COGS) is a term you may not know. It refers to the cost of items you buy that are included in the product sold to the customer. For instance, in a food business this includes the cost of ingredients, and in a retail business it includes stock for resale.

COGS is usually expressed as a percentage. For instance, if COGS is 30 per cent, it means 30 per cent of sales. Here is an example: Sales: $150,000 (100 per cent) COGS: $45,000 (30 per cent)

Gross profit: $105,000 (70 per cent)

Gross profit is simply the difference between sales and COGS.

As a franchisee, you will be required to buy many items from specified suppliers. In some cases, you may need to buy from the franchisor. You might hear that a franchise gives you the benefit of buying power for such purchases. This should mean you can buy supplies and materials at a lower price than many independent competitors.

It is important to satisfy yourself of this claim, and to understand what the actual COGS is for franchisees who are up and running.

Some franchises do not offer better buying prices, but rather provide you with access to exclusive products.

Your costs may be higher than a similar business down the street, but you will have access to a distinctive product aimed at a specific market.

MANAGING YOUR COSTS

Now you know what makes up these three important areas of cost, the question is how to make the most of the money you spend. This is where you add your skill as the business owner.

When you are new in business, you may find your costs are higher than those for an established franchisee, but as you become more familiar with the business you should seek to carefully and wisely manage your costs.

When it comes to managing costs, it is not a matter of simply cutting wages by employing the cheapest staff possible. This can do more harm than good if you end up with an unreliable workforce, poor customer service and waste.

A better approach is to think carefully about the right mix of staff members, blending experienced hands with juniors who are learning the ropes. At the same time, it can often pay to have fewer, more efficient and skilled staff than a bunch of less-competent people hanging around.

You can also consider using incentives to encourage staff members to increase sales or control costs. This keeps everyone focused on delivering results.

Rent is a fixed cost – there is nothing you can do to reduce it once you have agreed to it. So how can you make the most of the rent you are paying? Paying rent shows you have decided to be in a fixed location, so make the most of this. Think how to attract more people to your store. Look at the advantages of your location and exploiting them.

To control COGS, the key things to tame are waste and product mix. By reducing waste you reduce your COGS, so be sure to learn the tricks of the trade from experienced franchisees.

Product mix can have a huge effect. Find out which products are most profitable and learn how to combine the sales of these with lower-margin products. This is the art of sales and merchandising, and is a fundamental skill for a retailer.

One of the best ways to understand the financial aspects of your business is to ask questions about the different costs. Do not be afraid to ask the franchisor about the types of expense and what is included. Your franchise accountant can also help you understand the different costs and how they affect financial performance. SmartFranchise works with franchises to make sense of business information and use it wisely.