Parsing Item 19 – A Case Study
You may be somewhat reassured if the franchise in which you intend to invest provides Item 19 financial performance representations in its franchise disclosure document. That’s because the disclosure is optional and most franchisors choose not to provide it. Even if Item 19 disclosure is provided, however, you cannot let your sense of reassurance distract you from focusing on the task that lies ahead. Specifically, you need to determine:
- what is disclosed and, perhaps more importantly, what is not disclosed,
- whether the Item 19 disclosure is a reasonable basis upon which to think about average annual income, and
- how to use the disclosure to make a reasonable comparison to your situation.
Unless you carefully understand the Item 19 disclosure you will be unable to make these critical determinations. And if you cannot do this, you may be better off not reading the Item 19 disclosure in the first place rather than reading but misunderstanding it.
To illustrate these points, let’s take a closer look at Jimmy John’s Item 19 disclosure in its 2012 Franchise Disclosure Document (FDD).
What’s Disclosed. You don’t even need Jimmy John’s FDD to get started. Just go to their website. Here, Jimmy John’s provides some fairly compelling "facts and figures for people who like that sort of thing":
- Average Annual Gross Sales $1,360,396
- Average Food & Paper Costs 26.63%
- Average Net Profits from Operations $285,158
If you can’t plunk down your money fast enough and count yourself among the friends of "facts and figures," take a closer look at the website disclosure and then take a very close look at the FDD. Each of the above figures has an asterisk and, as it turns out, the facts and figures only reflect averages for 19 affiliate-owned restaurants that opened before January 1, 2007. Moreover, almost all affiliate-owned stores are located on college campuses, sites likely to generate significantly more traffic than a traditional strip mall in a town whose population remains unchanged when the fall semester begins. So what’s the big deal? Aren’t these figures a reasonable proxy for what you can hope to earn? Maybe, maybe not.
Other Start-up Costs 2,000
Total Costs not Included Examples $ 49,500
Adjusted Pre-Tax Profit $ 129,201
The operating profit drops from $350,337 and $261,262 all the way down to $178,701. But we can’t stop here if you want to get to your real pre-tax profit. The statements of income and cash flow in Jimmy John’s Item 19 disclosure don’t get you to this important metric. To get there, you need to account for upfront costs that come from your own resources or are financed. Whether they are self-funded or financed, these start-up costs still affect your bottom line. And, if they are financed, they will affect your cash flow as well. So, taking into account items like the franchise fee ($35,000), leasehold improvements and FF&E (the latter two derived from the high end of Jimmy John’s Item 7 Estimated Initial Investment range), and amortizing those costs over the 10 year franchise life, you come up with a net income (not including owner’s salary, management bonuses, administrative salaries, unit option plans and income taxes) of $129,201.
As you can see, Item 19 requires some careful parsing to help you understand what you really want to know: how much money can I make. If the $285,158 average operating profit caught your eye, you need to understand what’s behind that figure, whether it’s a reasonable basis to determine your own operating profit and how to make it a more apples-to-apples comparison. It’s really not a question whether "your individual results may differ." They will. The real question is by how much… for people who like that sort of thing.