Franchise accounting guide What counts as gross sales for franchise royalty?

Where is the royalty basis defined?

Two places, and you need both. Item 6 of the Franchise Disclosure Document lists every recurring fee, its amount and when it is due, with remarks and definitions in the table’s fourth column^[1]. The binding definition of the sales figure the royalty is charged on sits in the franchise agreement itself, usually in its definitions section. Item 6 tells you the royalty is “6% of Gross Sales”; the agreement tells you what Gross Sales is.

How different can two definitions be?

Three published examples, one each from a restaurant brand, a service brand and a hotel brand:

The rates are close. The bases are not. A retail-heavy wax centre, a delivery-heavy wing store and a hotel with high card-fee costs would each pay a different effective rate on their total revenue for reasons that live entirely in the definition.

What is usually excluded, and what usually is not?

• Sales tax — excluded in nearly every definition, because it is not the franchisee’s revenue.
• Refunds, voids and comps — usually excluded, but only when the register records them as such. A comp rung as a 100% discount and a comp rung as a void can land differently.
• Discounts and coupons — often excluded (Wingstop excludes coupon credits and employee discounts^[2]); sometimes royalty is on the pre-discount price.
• Gift cards — commonly excluded when sold and included when redeemed, so the royalty follows the sale of the product, not the sale of the card.
• Third-party delivery — the widest variation. Some agreements include the full menu price, some exclude the marketplace’s fees, some carve out delivery entirely.
• Retail product — excluded in some service brands, as at European Wax Center^[3].

What does a wrong basis cost?

Take a studio whose agreement charges 7% on sales less refunds and gift cards sold. In one week it takes $38,920 gross, refunds $610 and sells $1,480 of gift cards.

Gross sales                          38,920.00
Less refunds                           (610.00)
Less gift cards sold                 (1,480.00)
Royalty basis                        36,830.00

Royalty at 7% on the basis            2,578.10
Royalty at 7% on gross                2,724.40
Overpaid in the week                    146.30
Overpaid in a year (52 weeks)         7,607.60

That is one store. The error runs the other way just as easily: include a revenue line the definition names and leave it out of the report, and the franchisor’s audit will find it (see below).

What happens when the franchisor audits?

Franchise agreements give the franchisor the right to audit reported sales and to recover the shortfall with interest. Many shift the cost of the audit to the franchisee past a threshold; Wingstop’s agreement does so where Gross Sales were understated by 1% or more^[2]. Many franchisors can also poll the point-of-sale system directly — Wingstop may electronically poll the restaurant’s system for Gross Sales data^[2] — so the franchisor may already see the number you are about to report.

How do you keep the basis right every week?

1. Copy the definition clause, word for word, into wherever the royalty is calculated — not a paraphrase.
2. Map every register category (food, beverage, retail, gift card sold, gift card redeemed, delivery, catering, service charge, tax) to “in” or “out” of the definition once, per brand.
3. Book gift cards sold to a liability and delivery at gross, so the categories exist to be excluded.
4. Compute the royalty from the mapped total and compare it with the franchisor’s debit each week; a difference is either a restated day or a mapping error.
5. Re-read the definition at every renewal. Fees and definitions change with the agreement’s year.