The financial viability of any business depends on its ability to achieve its operating objectives and fulfill its mission over the long-term. A business must be able to generate sufficient income to meet operating expenses, debt service (principal and interest payments) and allow for growth while maintaining excellent customer experiences. This is an important concept to understand. In the coming weeks we will be discussing the various measures used to assess the viability of a McDonald’s franchise operation.
McDonald’s corporate accesses the financial viability of its franchisees through four measures:
- Balance Sheet Ratios:
- Cash Flow Coverage
- Working Capital
- Liability Turnover in days
- Organizational Equity
- Timely payments to McDonald’s and other vendors
- Accurate and timely transmission of financial information
- Does each restaurant’s level of reinvestments meet NRBES?
This article will focus on the first (and most important) financial ratio, Cash Flow Coverage.
Cash Flow Coverage, CFC, is the amount of cash left after G&A and Draw (Distributions) to pay debt service. CFC can be calculated by taking pre-debt cash flow (after G&A and Draw) and dividing by the debt service. McDonald’s guidelines call for a CFC ratio of 1.2 or greater. This means for every $1.00 of debt service there should be at least $1.20 in pre-debt cash flow, less G&A and draw.
Here is an example of the calculation. Your numbers may vary.
| Pre-debt Cash Flow: | $750,000 | |
| Subtract | ||
| G&A: | $140,000 | |
| Draw: | $180,000 | |
| $430,000 | ||
| Divide by | ||
| Debt Service (P&I): | $210,000 | |
| Equals | ||
| Cash Flow Coverage Ratio: | 2.04 |
The greater the coverage ratio is over 1.2, the better a company’s ability to meet its obligations along with having sufficient cash flow to expand its business, participate in the long-term reinvestment strategy, withstand commodity pressures and not be burdened with debt over the long term.
Here are some things you can do in your organization to increase your CFC ratio:
- Increase your profitability in your restaurants
- Review your G&A and reduce where applicable
- Decrease Draw
- Pay off and retire existing debt
Here are some things that may have a negative effect on your CFC ratio:
- Decreases in Profitability
- Increases in G&A
- Increases in Draw
- Taking on additional debt that is not supported by sufficient cash flow
Cash is King! It is our advice to continue to build cash in your organization. Remember, a company can generate all the revenue in the world but without its ability to generate and build sufficient cash, it risks failure. Keep a good handle on your CFC ratio, and track how it is trending.
Proper financial business planning, including tracking key indicators, is more important than ever. Spend the time with your CPA and trusted advisor to develop a proper plan.