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Wednesday 19th January, 2022

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Understanding the complex world of franchisee accounting

Insight

Understanding the complex world of franchisee accounting

From incorrectly recording data to the miscommunication of deductions in sales, keeping on top of your accounting can avoid revenue leakage

From incorrectly recording data to the miscommunication of deductions in sales, keeping on top of your accounting can avoid revenue leakage.

Are you getting all the franchising income that you are owed? Based on the work that we carry out for our clients, the answer is probably no. We’re not suggesting that your franchisees are deliberately hiding money from you – although, we have seen plenty of that, too! – rather, there are so many ways that a franchisee can mistakenly under-report revenues to you.

If your franchisee simply buys stock from you and sells it in their stores, that should be easy to control, as you can monitor what you have sold against what they have reported. However, if you take a more complex franchising model, for example, one based on time spent by staff or agency workers, then you are reliant on the workers inputting their time accurately, the franchisee recording this data on their system and invoicing correctly, and then having sufficiently sophisticated systems to ensure that the revenue reported to you is complete and error-free. If you have tens or hundreds of these franchisees, just think of the potential for revenue leakage.

Then there is the thorny issue of deductions that the franchisees make before reporting sales to you. First and foremost, are they permitted per the agreement? But even if the type of deduction is permitted, say a volume discount, you want to be sure that the deduction is for the correct value. Do you trust that the accounting system of the franchisee is set up in such a way as to accurately identify these deductions?

Gain control

So, what controls can you implement? Well, the best ones are those that are fully integrated with the franchisees’ accounting, so that when they are recording data, you get to see that in real-time. The beauty of such an integrated system is that it will flag up unusual transactions or patterns. The problem with such a system is that it will be expensive to set up and you need the right people on your side monitoring franchisee activity.

A cheaper alternative is to ensure that the reporting to you by franchisees is comprehensive and detailed. You want as much information about what, to whom and when they have sold. In theory, obtaining this detailed information should provide more confidence that what is being reported can be supported by underlying data, which you can analyze for anomalies.

Unfortunately, the bad news is that even if you have controls in place, you cannot be sure that you won’t be losing money, because you are still relying on the fact that the data being provided is accurate. The only foolproof way to be sure what you are receiving is complete, is to undertake audits of your franchisees.

By sending qualified and experienced forensic accountants to a franchisee’s premises, you can really get underneath the skin of the franchisee’s reporting.

Before you embark on a franchisee audit program, you should check your franchise agreements. Most agreements nowadays include a clause allowing for an audit, although the language used in audit clauses vary significantly.

We think that a robust audit clause should include the following:

+ Specify that the records that can be checked should include any documentation that allows the auditor to verify that the reporting has been complete and accurate, and the franchisee has complied with the agreement

+ Ensure that records can be audited back six years (being the length of time that companies should legally maintain accounting records in the U.K.)

+ Set a threshold for errors, above which the franchisee should pay for the costs of the audit. This is usually a percentage, typically three or five per cent, of amounts reported during the audit period. If your franchise agreement contains an audit clause, then you are good to go. Yet, despite having the right to audit and it now being commonplace to audit across industries as diverse as media, publishing and pharma throughout the world, we often hear a common objection to the auditing of franchisees. Many franchisors don’t want to disturb their relationship with franchisees.

In response to this, we would make the following points:

+ If auditing is done as part of a cyclical program of audits, franchisees should not feel that they are being singled out

+ Any company needs to implement corporate governance procedures to ensure that they are protecting their shareholders

+ If franchisees have undertaken their reporting duties with precision and care, they should have nothing to fear from an audit. Rather they should see it is an opportunity to display their diligence.

+ When audits are undertaken professionally, working hand-in-hand with the franchisee, the relationship with the franchisee can be enhanced

+ An audit can often be a learning exercise for a franchisor, shining a light on the franchisee’s practices. It is better to bring issues or agreement misunderstandings to a head as quickly as possible rather than letting them continue and fester for years

+ By undertaking audits of some of your franchisees, it is likely that the franchisee network will hear about it. This can have the effect of encouraging other franchisees to ensure that their reporting is accurate if they think they might be audited.

ABOUT THE AUTHOR

Rafi Saville and Stuart Burns are partners at HW Fisher, one of the U.K.‘s leading partner-led accountancy practices

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