How to Calculate Profit for Top Restaurant Franchises

Analyzing any financial representations made in a Franchise Disclosure Document is a crucial part of the due diligence process for any prospective franchisee. Entrepreneurs looking to invest in the restaurant space, which has notoriously thin margins, should pay close attention to Item 19 and conduct additional due diligence, when possible, to get a better understanding of how much they might actually be able to make.

Item 19 of the FDD is where a franchisor can legally make claims about the financial performance of its units. This can include detailed breakdowns of sales, expenses and profits, or it may just outline broad-stroke sales information, like median and average gross sales.

These numbers are important, but when you only see data about revenue, additional legwork is required to begin to estimate profitability. In an industry with thin margins, high sales volumes don’t necessarily guarantee high profits, making this evaluation even more important.

Estimating profitability

If a restaurant franchise only lists revenue in its FDD, you can still create a useful profit and loss estimate.

Start with average revenue. Look at the figure (or figures) provided in Item 19 to come up with a starting point. If the brand segments this data by type of build-out, market or the age of the restaurant, hone in on the numbers that most closely represent what kind of restaurant you intend to open.

Calculate the cost of goods sold. For restaurants, this includes all food and beverage costs. Industry-wide, a good COGS is between 28 and 35%, but the exact percentage will depend on what type of restaurant you’re considering. Research benchmarks that will allow you to pinpoint a more specific number.

Factor in labor costs. Labor is another significant expense for restaurant franchisees, with many restaurants aiming for labor to account for 30% or less of gross sales.

With these two numbers, you can estimate your prime cost. Ideally, the prime cost should be 60% or less of total sales.

In addition to prime cost, franchisees should consider rent or occupancy costs (5 to 10% of revenue), royalties (4 to 8% of gross sales), marketing and advertising costs (1 to 4% of sales), and other operational costs like utilities, insurance and supplies (5 to 10% of sales). All of these costs will vary depending on your franchisor, business model and market; use these ranges as a guideline, and research carefully to hone in on the amounts that will realistically apply to your situation.

Existing franchisee insights

While the FDD provides a wealth of information, existing franchisees are another invaluable resource. They can speak candidly about their personal experiences operating the business, and you can often get additional information from them that the franchisor legally cannot disclose.

The FDD should include a list of franchisees with contact information; call several and ask questions.

Individual owners may not feel comfortable sharing exact profit figures, but you can ask them about COGS, labor cost percentages and whether the revenue claims in the FDD seem realistic to them. This qualitative data can help you further hone your estimates and validate your financial projections or identify any potential red flags.

By combining revenue data from the FDD with industry-standard benchmarks and insights from current owners, you can build a strong picture of a franchise’s potential profit margins. To take it a step further and begin to understand what these figures will mean for you, specifically, you must also consider the upfront costs of the investment.

Evaluating investment

Determining a profit margin is a starting point, but applying this to costs and long-term returns is what will help you evaluate the strength of the opportunity. The franchise cost and how you choose to fund or finance things like the franchise fee, real estate, equipment and initial inventory should be a point of focus.

Any loan payments should also be considered when building a well-rounded P&L statement, and a higher initial franchise cost will require higher profit margins to achieve a good return on investment.

Making an informed investment decision in the competitive restaurant industry requires a careful analysis of the franchise opportunity. The revenue figures in the FDD are just the beginning of the story; the true narrative of profitability is found when you project expenses, consult with other franchisees and analyze how upfront costs will impact your bottom line. With comprehensive due diligence, you can paint a clearer picture of the opportunity and equip yourself to make an investment decision that aligns with your long-term financial goals.