Many franchisees wonder how liquidity affects franchise growth. Liquidity, also known as accessibility to cash, plays a key role in your franchise business growth. Most lenders look closely at the franchisee’s liquidity as it is sometimes the most important characteristic they evaluate.
When it comes to acquiring financing, liquidity requirements differ based on the lender and product. However, what a lender requires is only a small component to consider when thinking about your liquidity. One major aspect to consider when thinking about your liquidity is whether you have enough money on hand for initial expenses that come with either opening a business of ramping up sales. Franchise disclosure documents (FDD’s) tend to have a lot of information regarding typical costs you’ll face when opening a store, but that might not tell the whole story. Every franchisee has a slightly different route to opening a new store and these different routes come with differing costs. Contractors vary in costs build-outs vary in length of time, unforeseen expenses rise. This is why it is important to focus on liquidity and assess a risk factor to your plans before deciding how much cash to put down and how much to finance. For example: say you have $50,000 worth of liquidity and you put down $25,000 as a down payment on a loan. You borrow $200,000 to cover your new location, so you’re all in for $225,000 with $25,000 left in liquidity. What happens when your contractor comes in over quote, you have delays in shipping for some of your materials, and you come across unforeseen expenses in the building process? You could have to dip into your excess liquidity. Depending upon how much the unforeseen costs are you, you could really be hurting for cash when it’s time to open. This is why we recommend always have more cash than you think you need before making any business decisions.
In order to support franchise growth and minimize potential risk, you should approach your liquidity goals strategically. The more liquidity you have, the easier it will be cover unforeseen expenses and to obtain financing for your growth. One common thing we hear from borrowers is that they plan to “self-finance” their expansions, doing everything they can to avoid taking on debt. While this may appear to be a smart approach in order to avoid interest expenses, this strategy can actually backfire and can back franchisees into a corner that will hinder growth. Bleeding through all of your liquidity in order to avoid interest can lead you to a place where you don’t have enough cash on hand to pay employees, purchase materials to meet a rush in sales, or afford rent and utilities expenses. Additionally, business purchases made with business loans can also have the interest expense written off when filing taxes which will save you money as well. We recommend a healthy mix between using cash for down payments and financing of small projects, and using business loans to pay for the more expensive projects that could ruin cash flows if self financed.
Liquidity is a vital piece to both borrowing eligibility and franchise growth. Using liquidity strategically in combination with business loans can reduce your risk, offer greater security, and open up the door to faster expansion.