What to Expect During a Franchise Audit

It’s important for franchisors to periodically audit individual franchisees. These routine “check-ups” are especially valuable in a store’s early years of operations or if performance starts to deteriorate. They can be used to detect symptoms of unhealthy performance and treat problems before they spiral out of control.  Focus on royalty payments

It’s important for franchisors to periodically audit individual franchisees. These routine “check-ups” are especially valuable in a store’s early years of operations or if performance starts to deteriorate. They can be used to detect symptoms of unhealthy performance and treat problems before they spiral out of control.
 Focus on royalty payments
 Royalties are a franchisor’s primary source of income. Because royalties are typically based on a percentage of revenue, auditors pay close attention to the franchisee’s revenue reporting process.
 To test whether revenue has been accurately reported, auditors trace transactions from the point-of-sale to:
 *           The franchisee’s financial records,
*           Revenue reported to the franchisor, and
*           Tax returns submitted to the state and federal government.
 If the revenue trail doesn’t hold up, further investigation may be required. In addition to vouching a representative sample of randomly selected sales transactions, auditors use analytical techniques to compare key metrics for an individual franchisee against benchmarks for franchises of a similar size and others in your franchise system. Any discrepancies from these benchmarks raise a red flag that the franchisee may have underreported revenue to minimize royalty payments.
 Standard operating procedures
 Beyond testing revenue, auditors spend extensive time examining whether the franchisee has complied with the franchise agreement. They consider such questions as:
 *           Is the franchisee spending the required amount on advertising?
*           Does its signage comply with brand standards?
*           Is the franchisee purchasing materials and supplies from approved vendors?
*           Is the HR manager conducting appropriate employee background checks?
Failure to comply with such terms compromises future revenue and the reputation of your brand. So, areas of noncompliance should be identified during the audit — and corrected as soon as possible.
 
Site visits
 Analyzing a franchisee’s books and records can only reveal so much. There’s no substitute for meeting face-to-face with the owner-operator.
 Site visits give the auditor an opportunity to assess business operations from the customer’s perspective, evaluate the condition of equipment and the morale of workers, and interview the management team. These inquiries help the auditor understand how the business operates and investigate any anomalies unearthed during testing and analytical procedures.
 Need help?
 Hiring an outside auditor to enforce the audit provisions of your franchise agreement brings objectivity and financial expertise to the process. In addition to auditing a franchisee’s financial statements, our team can follow up on any compliance issues unearthed by the audit. Contact us for more information.
 Does your franchise agreement include an audit provision?
These routine “check-ups” help evaluate whether owner-operators are embracing your business model and complying with the terms of the franchise agreement. For example, are franchisees shortchanging you on royalty payments, using unauthorized suppliers, skipping background checks on new hires or skimping on advertising? Failure to comply with such terms compromises future revenue and the reputation of your brand. We can help enforce the audit provisions of your franchise agreement, as well as bring objectivity and financial expertise to the audit process.