Multi-Unit Franchisee Magazine Issue III, 2011 | Page 68

Finance
By Steve LeFever

Expansion Analysis
Sales are only half the answer

G

rowth: the all-American measure of success. But it’s a “go.” The other way around, and it’s a “no-go.” I leave it to
what kind of growth? And how do you measure growth you to assess how often they’re right. However, I make the folin relation to success? For too many businesses, intel- lowing observation: such an analysis is not possible unless you
ligent and well-intended
know your costs.
owners settle for sales volFacts:
Working the
ume alone as the primary
numbers
indicator of achievement.
Variable cost (%) =
60%
Don’t get me wrong,
Several years ago, one of my
Fixed costs
= $250,000
sales are important. I’m not
clients came to me ready
Target profit
= $200,000
trying to appear un-Amerto expand. He had four
ican or anything, but my
stores and was opening
premise here is that often
a fifth. Naturally, I asked
Formula: Required sales = Fixed costs + Target profit
growth—or expansion—
him: “What are your fixed
100% – Variable cost %
occurs without an effective
costs?” His answer: “I don’t
analysis or understanding of
have the foggiest idea. How
Calculation:
the underlying costs.
can I find out?” My suggesFor most businesses,
tion, of course, was to look
$450,000 = $450,000
= $1,125,000 required sales at his other four stores. He
growth means expand100% – 60% =
.4
ing existing facilities or
told me annual fixed costs
were $220,000. Knowing
opening additional outlets.
However, expansion costs money and the analysis has two as- this client, I applied Murphy’s Law and arrived at a figure of
pects: financial and marketing. Financial answers the question: $250,000.
“What do we need?” Marketing answers the question: “What
Next, I asked him what his variable cost percentage was. Same
will we get?”
answer. Naturally, you find the variable
Here’s an example from the folks who
cost percentage the same way. He told me
are best at this: the Golden Arches. Do
his variable costs were 60 percent of sales.
they know their costs? Down to the last
Now all I needed to know was how
McCrumb. Suppose they are looking at
much he would need to invest and his
a new location. By knowing accurately
required ROI. He planned to invest $1
their fixed and variable costs, they can
million and his required ROI was 20 percent. Therefore, of course, he needed to
calculate a break-even sales volume level.
make $200,000 per year. I’ve diagramed
Where do they find this accurate cost inthe financial analysis (above).
formation for the new store? They have
thousands of existing outlets to use as
What this says in words is: With a
models, so by knowing how much they
variable cost percentage of 60 percent, my
need to invest and their target ROI they
client must achieve sales of $1,125,000 to
can calculate the required profit. Then, considering the target cover fixed costs and produce the target profit. His comment to
profit as “fixed”—the cost of money—they can easily calculate me: “That sounds okay, but can I do it?”
the required sales to cover the costs and supply the necessary
My answer: “How should I know? I’m just a finance guy!” To
profits. Okay, halfway there.
do the other half of the analysis (the marketing part) required
Simultaneously, the marketing folks are conducting a demo- additional effort. So I dispatched myself to the small town he’d
targeted for expansion and reviewed the
graphic survey, researching and analyzing
the target market area. By projecting most
market. My competitor analysis is outCompetitor 1
$ 650,000
likely customer volume and knowing the
lined at left.
As I saw it, my client needed a 50 peraverage customer spend they can accuCompetitor 2
550,000
cent market share. What’s the likelihood
rately predict sales (“What will we get?”).
Competitor 3
500,000
Now it’s complete.
of getting that in a small market where
Sales going out of town 500,000
Next, the marketing and finance people
he’s unknown and all three competitors
Total market $2,200,000
meet and put the puzzle together. If what
are both known and well-established?
you will get is greater than what you need,
About the same as the proverbial snowball!

Financial answers the
question: “What do
we need?” Marketing
answers the question:
“What will we get?”

66

Multi-Unit Franchisee Is s ue III, 2011