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Important to Read Notes in a Franchisor's Financial Statements

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Richard Solomon makes an excellent point about about how to figure if a franchisor is selling but not but not building out franchises.

"The AICPA accounting rules for franchisors call for segregation of revenue from initial franchise fees until the store is up and running.

Only franchise sales revenue from stores open and operating should be included in the general statement of gross sales.

In franchise registration states where there is some review of the registered materials, a thinly capitalized franchisor will be required to place initial fees revenue into an escrow account until the franchisee is up and running and signs a release of funds statement acknowledging that he has received the promised initial support needed to get up and running.

This phenomenon is that important. This isn't nit picking here.

If it is included in gross sales - as it almost always is - there should be a footnote by the gross sales entry in the financial statement that takes you to a note to the financial statement showing the amount of initial fees income that is attributable to sold but unopened franchises."

Most franchise agreements specify that the franchise fee is earned upon the signing of the franchise contract and not when the franchisor's obligations to open the store have been performed.

This is technically how they skirt the accounting issue.

Since the fee is "earned" upon the signing of the contract, franchisors argue that they don't have to treat it as deferred revenue.

Personally, I think that this is crock.

Full post as published by Misleading Advertising Law on December 01, 2008 (boomark / email).

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