Published on March 2, 2014
. FINANCIAL PLAN – FRANCHISE’S PERSPECTIVE Happy Learning Center February 2014
CONTENTS 1 OBJECTIVE______________________________________________________________________1 2 APPROACH______________________________________________________________________2 3 INTRODUCTION___________________________________________________________________3 4 INCEPTION COST_________________________________________________________________4 5 STARTING PROFIT AND LOSS______________________________________________________8 6 ONE TIME EXPENSES_____________________________________________________________10 7 RECURRING EXPENSES__________________________________________________________11 8 TAX IMPLICATIONS AND COMPLIANCES____________________________________________12 9 TREND AND RATIO ANALYSIS_____________________________________________________15 10 CONCLUSION___________________________________________________________________16 -1–
1 Objective_____________________________________ The purpose of this report is to review the financial implications of the Franchise arrangement between franchisor and Franchisee. The report outlines the financial structure from a Franchisee‟s perspective. Broadly, the report would serve the following purposes: Highlight the financial implications from a Franchisee‟s perspective; Identifying the financial requirements to start the business; Indentifying the financial requirements to keep the business profitable and liquid; Analyzing the financial performance of the business over a period of time; Analyzing various ratios and doing a trend analysis; Review of the financial structure from a Franchisee‟s perspective; and Assistance in taking significant business decisions based on financial implications. (This space is intentionally left blank.) -1–
2 Approach____________________________________ The financial projections have been prepared on a very conservative basis. This approach is adopted since it's not possible to project the unexpected delays or challenges that always seem to happen in any new Franchise setup. We build our financial models based on the following quote: “Use conservative estimates to produce realistic models” Following is an overview of the approach which we aim to highlight in our financial plan. Interlinkage between different financial planning aspects for a franchisee Balance sheet planning Income statement planning Planning of financial elements Sales Fixed assets Planning of revenue - Expenses - Depreciation Current assets Equity capital Planning of investments Planning of expenses Operating income Debt capital Total liabilities and equity - Interest - Taxes Planning of capital requirements Net income Debt financing Planning of financing Planning of cash flow requirements -2– Industry trends / aspects to be considered for all start ups Supported by Assumptions Total assets
3 Introduction__________________________________ Happy Learning Center established in 2006, it is home based K12 tutorial institute, helps children to increase the mental strength by several innovative ways. It is one the most highly rated tutorials were people come from 15 km distance to study The company is now looking at expanding its operations in India and is keen on opening Franchise units. The financial projections of the Franchise units have been observed in the present report. (This space is intentionally left blank.) -3–
4 Inception cost________________________________ Inception cost or the start up cost is the cost of starting any business. It is the cost or expense associated solely with the implementation of a plan or project and typically represents the cost incurred prior to the realization of benefits from such a plan or project. The objective is to lay down all the significant cost elements which should be owned by any business to venture into the Franchise setup. Following are the broad categories of cost elements to setup a Franchise of Happy Learning Center: The estimated area required for starting a franchisee of Happy Learning Centre is approximately 500 sq ft. Centre Furnishing / Improvement Furniture / Fixtures / wood work Signage (Int / ext) Equipments Laptops Projector Printer/Scanner/Fax CCTV Sound System Communication equipments & Internet Connection LCD Misc (display boards, stationery etc.) Business promotion Launch & Pre-Opening Marketing Expenses Software & Licensing cost Training (Lodging & Boarding) -4–
Working capital In addition to the above, there are certain working capital requirements which the Franchisee will have to make provisions for. Such requirements are imperative from an operational stand point as there is some level of liquidity which the Franchisee would need to have at the inception. Franchise fees The methodology for fee determination calls for Franchisors to look to their primarily as a cost recovery tool and only secondarily as a profit centre. Franchisors would obviously like to maximize their Franchise fee revenue, but knowing the importance of establishing the associated royalties, most Franchisors price their fees low enough to avoid erecting barriers to the Franchise sale. In determining simultaneously: Franchise fees, several approaches can be used Cost-Plus Approach: The cost-plus approach is one way to determine the "floor" level above which a Franchise fee should be set. To establish this floor, the Franchisor calculates its Franchise acquisition, total marketing, training, and initial support costs involved in selling a Franchise and add a reasonable markup. Based on Francorp experience, 15% component of Franchise Fee is the Franchise Acquisition cost, which turns out to be 5% of the Project Cost. However, in product Franchises where franchisor is already enjoying a certain margin on the supplied merchandise, it is advisable to either waive off the Franchise Fee or set it at a level which does not serve as resistance in Franchise sales. However, Francorp would advise the client to make a re-assessment during next discussion on the following lines: Expenses per Franchisee Marketing and Lead Generation Expenses + Sales Expense -5–
+ Site Evaluation + General & Administrative Expenses + Headquarters Training + On-Site Training and Travel + X-factor: Initial Support Competitive Approach: Francorp recommends a "ceiling" price for the Franchise by considering what the market will bear. Upon examining the Franchise fees of "competing" franchisors, Francorp found INR 150,000 as the suitable Franchise Fee Perceived Value Approach: Finally, Francorp uses this approach to determine where a Franchise fee should be set above the "floor" price. [Note: Some franchisors will intentionally price above the ceiling price to establish the "exclusivity" of the Franchise offering, while others will price well below its assumed costs in an effort to saturate the market.] Although relatively few examples exist of companies entering franchising with a high degree of name recognition, those that do exist can position their offering toward the high end of the competitive spectrum. Premium positioning is not a license to charge more than the market price in the face of established successful franchise competition. It is, however, grounds to avoid the introductory pricing that beginning franchisors often charge to get a foothold in the market in a field dominated by a few big names. Based on the financial results that the Franchisor expects Franchisees to achieve, its positioning in the industry, sales goals, and the level of support it intends to provide, a Franchise fee of INR 150,000 will be charged. The Franchise fees paid by the Franchisee shall also be subject to the applicable service tax. Presently, the same is applied at the rate of 12.36 percent. -6–
Assumptions Following are the broad assumptions which we have relied on while arriving at the start up cost: Based on our industry analysis and the inputs from Happy Learning Center, we have assumed that the initial marketing cost for a Franchisee of Happy Learning Center would be around INR 50,000. The working capital requirements of the Franchisee have been worked out presuming a 3 months gestation period. Based on our industry analysis we have assumed that the Franchise fees for this Franchise setup would be INR 150,000. The details of the project cost are provided in Franchise setup cost (A1). (This space is intentionally left blank.) -7–
5 Starting profit and loss_________________________ In order to assess the financial efficiency of the Franchise business to the Franchisee, the preparation of a detailed income projection statement is imperative. The statement aims to highlight the income / loss which the Franchisee would enjoy/ bear in the first 5 years of its operations. The statement is prepared based on the following format: Income from operations / Revenue / Turnover Less: Cost of goods sold Cost of operations Depreciation Profit before tax Less: service tax / VAT Profit after tax _____________________________________________________________ In the instant case, following are the broad heads considered to arrive at the profit forecast for the Franchisee: Revenue Revenue from Coaching Expenses Cost of Educational Kit Delivered Employee Cost Referral to Faculty Incentives to Full time Faculty Commission to Part Time Faculty Royalty to Franchisor Rent Electricity -8–
Cost of refreshments/gifts Communication Expenses (Tel + Internet) Printing & Stationery Quality Monitoring Charges Misc Expenses Marketing Expenses o Local marketing overhead o Contribution to central marketing fund Depreciation The various assumptions adopted in preparing the income forecast are enumerated as below along with the basis of such assumptions: The Royalty given by the franchisee to the franchisor will be 15 percent of total Gross Receipts. Based on our industry analysis, we have presumed that on an average the revenue of the Franchisee would increase by approximately 20 percent. The employee cost has been arrived by considering the cost of each employee of the Franchise. The number of employees as presumed is an estimated manpower requirement from Happy Learning Center perspective. It is also presumed that the overall employee cost would increase at an average rate of 5-10 percent. The complete computation of the HR cost is provided in Franchise HR cost (A2). The complete revenue model of the Franchisee over a period of 5 years is provided in Franchisee Revenue Statement (A3). The depreciation rate employed is 10 percent. The total marketing overhead are categorized as follows: o Local marketing overheads – 1.5% of gross revenue o Contribution to central marketing fund – 1.5% of gross revenue Based on the discussions with Happy Learning Center, we have assumed that the average increase in the operating expenses of the Franchise unit would range between 5-10 percent subject to the corresponding increase in revenue. The details regarding the 5 year income projections of the Franchisee of Happy Learning Center are provided in Franchisee Income Statement (A4). (This space is intentionally left blank.) -9–
6 One time expenses____________________________ One-time costs related to the business are usually considered capital expenses. This includes expenses such as the purchase of new equipment and related costs. The main reason for separating operating cost and one time costs is that it gives the company, and any investors, a more detailed picture of where money is spent before it can be turned into profit. In the instant case, the initial project cost is the one time cost for the Franchisee. The same is provided in Franchise setup cost (A1). In case the Franchisee aims to diversify or expand its scope of services then additional capital expenditure at a later date will also be classified as a one time cost. (This space is intentionally left blank.) - 10 –
7 Recurring expenses___________________________ Recurring cost is the cost incurred repeatedly, or for each item produced or each service performed. It is the operating cost of the business and is essential for the functioning of the Franchise. In the instant case, following are the operational cost which will be imperative to the functioning of the Franchise unit by the Franchisee: Cost of Educational Kit Delivered Employee Cost Referral to Faculty Incentives to Full time Faculty Commission to Part Time Faculty Royalty to Franchisor Rent Electricity Cost of refreshments/gifts Communication Expenses (Tel + Internet) Printing & Stationery Quality Monitoring Charges Misc Expenses Marketing Expenses o Local marketing overhead o Contribution to central marketing fund Depreciation The aforementioned expenses are incidental to the main business of the Franchisee and therefore will be modified as and when the Franchisee expands its scope of services. (This space is intentionally left blank.) - 11 –
8 Tax Implications and compliances_______________ The Franchise arrangement between the franchisor and Franchisee would result into tax implications for the Franchisee from both Direct and Indirect tax perspective. A prima facie view of the applicable tax implications are enumerated below: Direct tax Every company operating in India is liable to comply with the provisions of Income-tax Act, 1961 (Act) and to pay taxes on the income earned at the applicable rates. The Franchisee would be liable to pay corporate taxes at 30 percent (plus surcharge and cess as applicable) on the income earned during the year, as computed in accordance with the provisions of the Act. Alternatively, in case the tax on book profits at 18 percent (plus surcharge and cess as applicable) exceed the tax computed under the normal provisions, the Franchisee would be liable to pay such tax. The income tax is required to be deposited to the credit of the Central Government through the advance tax mechanism in four instalments during the financial year. The amount of such instalments shall be as follows: by the 15th day of June of the financial year - 15 percent of tax payable by the 15th day of September of the financial year - 45 percent of tax payable by the 15th day of December of the financial year - 75 percent of tax payable by the 15th day of March of the financial year - 100 percent of tax payable Indirect tax Sales tax Sale tax is a tax on sale of goods in India. In India there is a federal system of taxation where by: o Inter-state sales of goods (i.e. where goods move from one state to another pursuant to a contract of sale) are subject to CST and are governed by the provisions of Central Sales Tax Act, 1956 („CST Act‟); and - 12 –
o Intra-state sales of goods (ie sale of goods within the states) are subject to VAT and accordingly the provisions of VAT of the respective State shall apply. Sale of goods in the course of exports and imports are beyond the purview of Indian VAT/ CST regime. VAT is typically a multiple point levy which provides for levying tax at each stage of sale of goods within the state. However, there are a few exceptions to this general principle (for example petroleum products in most of the states are taxed at single / first point of sale within the state). Typical VAT rate is 12.5 percent (also known as revenue neutral rate) while specified capital and other goods enjoy concessional VAT rate of 4 percent. For example, in most states the VAT rate of intangibles and of iron and steel items is 4 percent. Service Tax Service tax is levied on provision of „specified taxable services‟. At present, there are more than 110 such specified taxable services on which service tax is levied. The current rate of service tax is 12.36 percent. Service tax is levied on taxable services provided by a service provider in case the total value of services rendered (including exempt) services exceeds the threshold limit prescribed in this regard. (presently threshold stands at INR 1 million) Typically, service provider is statutorily liable to register and pay service tax to the Government. However, in certain cases, the statutory liability to register and deposit service tax to the Government is on the service recipient. The exceptions, as relevant to the Franchisee of Happy Learning Center are any taxable service provided by a person who does not have any business/ fixed establishment in India. In such a scenario, the liability to discharge service tax liability shall be on Indian service recipient under reverse charge mechanism. Like excise duty, service tax also works under credit mechanism whereby a service provider can typically avail the credit of service tax paid on inputs, capital goods and input services to be adjusted against the payment of output service tax. Service tax is payable on receipt of value of taxable services provided by the service provider to the service recipient. - 13 –
A service provider or a person liable to pay service tax as a recipient of services is required to apply for a registration with the service tax authorities. In the instant case, there can be specific tax implications subject to the categorization of the Franchisee‟s services under various tax clauses as enumerated in the Act. These tax implications need expert guidance and analyses and thus have not been captured as a part of our report. The various tax rates applicable for Financial Year 2013-14 are provided in Annexure A of this document. (This space is intentionally left blank.) - 14 –
9 Trend and ratio analysis________________________ The objective of this section is to analyse the financial performance of the Franchisee by doing a rigorous ratio and trend analysis. Our observations and results from the analysis are enumerated as below: There is an optimistic trend apparent from the profitability of the Franchisee. The initial set up cost of the Franchise is approximately INR 730,000 – 1,145,000 and is subject to increase depending on the add-on services which the Franchisee may wish to offer. ROI – The return on investment of the Franchisee shows and upward trend and serves as a lucrative opportunity. ROI (%) 300% 250% 200% 150% ROI (%) 100% 50% 0% 1 2 3 4 (This space is intentionally left blank.) - 15 – 5
10 Conclusion___________________________________ This report including the observations contained herein has been developed on a coherent, theoretically and grounded comprehensive framework for financial planning in a Franchise setup. Before starting with any quantitative projection, the Franchisee gathers and analyses information concerning the new venture, conducts a thorough market analysis to specify market needs, evaluate relevant external threats and opportunities, as well as internal strength and weaknesses. This leads to assumptions and connections which build up the foundation of the whole financial planning process. Thus, the sales volume and price can be extracted from the preceding analyses and written justification. The revenues determine related expenses and a derived production plan specifies the needs of capital investments. Aggregation based on which the entrepreneur calculates capital requirements. The next step is the planning of financing which initiates an adjustment mechanism due to financial “bottlenecks” that leads to an iterative planning process. Finally, the robustness of the financial plan can be tested by employing trend and ratio analysis. These methods are applied to financial planning elements and components and results in a cost effective and profitable Franchise setup. - 16 –
Appendix A Income tax rates in India These rates are subject to the enactment of the Finance Bill2013. The rates are for the Financial Year 2013-14. 1. Income tax rates 1.1 For Individuals, Hindu Undivided Families, Association of Persons and Body of Individuals Total income Up to INR 200,000, *,**,***,**** INR 200,001 to INR 500,000 INR 500,001 to INR 1,000,000 INR 1,000,001 and above Tax rates Nil 10% 20% 30% * In the case of a resident individual of the age of sixty years or above but below eighty years, the basic exemption limit is INR 250,000. ** In the case of a resident individual of the age of eighty years or above, the basic exemption limit is INR 500,000. ***Rebate from tax of upto INR 2,000 available for a resident individual whose total income is below INR 500,000 ****A 10 percent surcharge is applicable if the total income exceeds INR 10,000,000. Marginal relief available. *****A 3 percent education cess is applicable on income-tax (inclusive of surcharge, if any) 1.2 For Co-operative Societies Total income Up to INR 10,000 INR 10,001 to INR 20,000 INR 20,001 and above Tax rates 10% 20% 30% On the above, a 10 percent surcharge is applicable if the total income exceeds INR 10,000,000, Marginal relief applicable. Education cess is applicable @ 3 percent on income-tax. 1.3 For Local authorities - 17 –
Local Authorities are taxable @ 30 percent. A 10 percent surcharge is applicable if the total income exceeds INR 10,000,000, Marginal relief applicable. Education cess is applicable @ 3 percent on income-tax. 1.4 For Firms [(including Limited Liability Partnership (LLP)] Firms (including LLP) are taxable @ 30 percent A 10 percent surcharge is applicable if the total income exceeds INR 10,000,000, Marginal relief applicable. Education cess is applicable @ 3 percent on income-tax. 1.5 For Domestic Companies Domestic companies are taxable @ 30 percent. Special method for computation of total income of insurance companies. The rate of tax on profits from life insurance business is 12.5 percent. A 5 percent surcharge is applicable if the total income exceeds INR 10,000,000 but does not exceed INR 100,000,000. Marginal relief available A 10 percent surcharge is applicable if the total income exceeds INR 10,000,000, Marginal relief applicable. Education cess is applicable @ 3 percent on income-tax (inclusive of surcharge, if any). 1.6 For Foreign Companies Foreign companies are taxable @ 40 percent A 2 percent surcharge is applicable if the total income exceeds INR 10,000,000 but does not exceed INR 100,000,000. Marginal relief available A 5 percent surcharge is applicable if the total income exceeds INR 100,000,000. Marginal relief available Education cess is applicable @ 3 percent on income-tax (inclusive of surcharge, if any). 2. Minimum Alternate Tax (a) Companies MAT is levied @ 18.5 percent of the adjusted book profits in the case of those companies where income-tax payable on the taxable income according to the normal provisions of the Act), is less than 18.5 percent of the adjusted book profit. - 18 –
A 5 percent surcharge is applicable in case of domestic companies, if the adjusted book profit exceeds INR 10,000,000 but does not exceed INR 100,000,000. Marginal relief available A 10 percent surcharge is applicable in case of domestic companies, if the adjusted book profit exceeds INR 100,000,000. Marginal relief available Education cess is applicable @ 3 percent on income-tax (inclusive of surcharge, if any). MAT credit is available for ten years. (b) Person other than a Company AMT is applicable to persons other than Company AMT is levied at 18.5 percent of the adjusted total Income in case of persons other than a Company where income-tax payable on the total income (according to the normal provisions of the Act) is less than 18.5 percent of the adjusted total Income AMT will not apply to an Individual, HUF, AOP, BOI or an Artificial Judicial Person if the adjusted total income of such person does not exceed INR 2,000,000 A 10 percent surcharge is applicable if the adjusted total income exceeds INR 10,000,000. Marginal relief available A 3 percent education cess is applicable on income-tax (inclusive of surcharge, in any) AMT credit is available for ten years. 3. Securities Transaction Tax Securities Transaction Tax (STT) is levied on the value of taxable securities transactions as under: Transaction Rates Until 31st May 2013 Payable by From 1st June 2013 Purchase/Sale of equity shares (delivery based) 0.1% 0.1% Purchaser / Seller Purchase of units of equityoriented mutual fund (delivery based) 0.1% Nil - 19 – Purchaser
Sale of units of equity-oriented mutual fund (delivery based) 0.100% 0.001% Seller Sale of equity shares, units of equity oriented mutual fund (non-delivery based) 0.025% 0.025% Seller Sale of an option in securities 0.017% 0.017% Seller Sale of an option in securities, where option is exercised 0.125% Sale of a futures in securities 0.02% 0.010% Seller Sale of unit of equity oriented fund to the Mutual Fund 0.250% 0.001% Seller 0.13% Purchaser 4. Commodity Transaction Tax CTT is proposed to be levied (effective from a date to be notified) on the value of taxable commodities transactions as follows: Transaction Rates Payable by Sale of commodity derivative (other than agricultural commodities) entered in a recognized association 0.01% Seller 5. Wealth Tax Wealth tax is imposed @ 1 percent on the value of specified assets held by the taxpayer on the valuation date (31 March) in excess of the basic exemption of INR 3,000,000. 6. Dividends Earned by an Indian Company Dividends earned by an Indian company from a foreign Company in which it holds 26 percent or more equity shares shall be taxable at the rate of 15 percent (plus applicable surcharge and education cess) on gross amount of such dividends. 7. Dividend Distribution Tax Dividend distributed by a Domestic Company is exempt from income-tax in the hands of all shareholders. The Domestic Company is liable to pay DDT @ 16.995 percent (inclusive of applicable surcharge and education cess) on such dividends. - 20 –
For computation of DDT, the amount of dividend declared by the Domestic Company will be reduced by the amount of dividend, if any, received by it during the financial year if – (a) Dividend received from domestic company if o o such dividend is received from its subsidiary (i.e. in which it holds more than 50 percent of equity shares); the subsidiary has paid DDT payable under section 115-O of the Act. (b) Dividend received from foreign company (effective from 1 June 2013) if o o the dividend is received from its subsidiary; (i.e. in which it holds more than 50 percent of equity shares); the tax on such dividend is payable by the domestic holding company under section 115BBD of the Act. (c) Dividends paid to any person for and on behalf of a New Pension System Trust. Income received by unit holders from a Mutual Fund is exempt from income tax. The Mutual Fund (other than an equity oriented Mutual Fund) is liable to pay income distribution tax as follows: o 28.325 percent (inclusive of applicable surcharge and education cess) on income distributed to any person being an individual or a HUF by a money market Mutual Fund or a liquid fund o 33.99 percent (inclusive of applicable surcharge and education cess) on income distributed to any other person by a money market Mutual Fund or a liquid fund o 14.163 percent (inclusive of applicable surcharge and education cess) till 31 May 2013 and 28.325 percent (inclusive of applicable surcharge and education cess) from 1 June 2013 on income distributed to any person being an individual or a HUF by a debt fund other than a money market mutual fund or a liquid fund; o 33.99 percent (inclusive of applicable surcharge and education cess) on income distributed to any other person by a debt fund other than a money market mutual fund or a liquid fund; and 5.665 percent (inclusive of applicable surcharge and education cess) on income distributed to non-resident or foreign company by Mutual Fund under an Infrastructure Debt scheme. - 21 –
8. Special rates for non-residents 8.1 The following incomes in the case of non-resident are taxed at special rates on gross basis: Nature of income Rate Dividend 20% Interest received on loans given in foreign currency to Indian concern or Government of India 20% Interest received on notified infrastructure debt fund 5% Income received in respect of units purchased in foreign currency of specified mutual funds / UTI Royalty 20% For Agreements entered into: –– On or After 1 April 1961 but before 1 April 1976 - @ 50% –– On or After 1 April 1976 - @ 25% Fees for technical services For Agreements entered into: –– On or After 1 March 1964 but before 1 April 1976 - @ 50% –– On or After 1 April 1976 - @ 25% Interest on FCCB, FCEB / Dividend on GDRs(b) 10% For a foreign company, a 2 percent surcharge shall be applicable, where the total income exceeds INR 10,000,000 but does not exceed INR 100,000,000 and at 5 - 22 –
percent where the total income exceeds 100,000,000. For other persons, a 10 percent surcharge shall be applicable, where the total income exceeds INR 10,000,000. Marginal relief available. A 3 percent education cess is applicable on income tax (inclusive of surcharge, if any). Other than dividends on which DDT has been paid. If the non-resident has a Permanent Establishment in India and the royalties/fees for technical services paid are effectively connected with such PE, this could be taxed at 40 percent (plus surcharge and education cess) on net basis. - 23 –
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