Franchise Tutorials Franchisee

Tutorial 22: Intro to Audits

When you enter into a franchise agreement, you acquire the rights to operate the franchisor’s proven business model. And just as you receive specific rights under this agreement, you also commit to certain obligations.

Franchisors trust that their franchisees will comply with the franchise agreement, and although you are contractually obligated to fulfill this partnership, what you may not know is the franchisor/franchisee relationship is largely based on good faith.

No, you didn’t read that last sentence wrong!

Though it may be a rarity, franchisees may choose not to follow the franchisor’s system or intentionally not report sales. To ensure such cases don’t happen, you’ll notice your franchise agreement has something to address the potential problem – audits.

A typical franchise agreement will give permission to a franchisor to perform a financial or operational audit on its franchisees, whether that be at random or when they notice something suspicious.

Let’s delve into what each type of audit entails.

During a financial audit, franchisors will look into monthly reported franchisee sales, comparing the numbers to franchisee sales reported to the company’s point-of-sale system, which includes sale invoices, government tax filings, inventory turnover and bank deposits. These numbers should all match up. If they don’t, it could simply mean there was an accounting error. Alternatively – and more seriously – it could mean there was an intentional underreporting of sales on the part of the franchisee to avoid paying royalties.

Typically, if a franchisee underreports sales greater than 3%, they will have to pay for the cost of the audit in addition to the outstanding royalties.  And if the issue continues, it could result in the termination of the franchise agreement.

Contrary to a financial audit, an operational audit is completed by successful franchisors who want to ensure their franchisees are following brand guidelines. An operational audit can be a one-on-one meeting between a franchisor and franchisee, or could be something a little more undercover.

You’ve probably heard of something called a mystery shopper. Well, these shoppers are used by franchisors to check on the state of their franchise location without the franchisee knowing. Still, no matter how the franchisor chooses to conduct an operational audit, what they look for typically remains the same and can include:

  • Location cleanliness and appearance
  • Use of brand logo and advertising
  • Use of products and services
  • Quality and presentation of products and services
  • Speed of service
  • State of equipment
  • Confirmation of proper licenses and insurance
  • Compliance with required labour laws and minimum wages
  • Required hours opened for business

As a franchisee committed to growing your business and helping the franchise succeed, you’ll welcome both financial and operational audits. They are meant to protect your investment, and the feedback you receive from them will be invaluable when improving your operations!

The opinions or viewpoints expressed herein do not necessarily reflect those of the Canadian Franchise Association (CFA). Where materials and content were prepared by persons and/or entities other than the CFA, the said other persons and/or entities are solely responsible for their content. The information provided herein is intended only as general information that may or may not reflect the most current developments. The mention of particular companies or individuals does not represent an endorsement by the CFA. Information on legal matters should not be construed as legal advice. Although professionals may prepare these materials or be quoted in them, this information should not be used as a substitute for professional services. If legal or other professional advice is required, the services of a professional should be sought.