Friday, 8 April 2011

Financial Fair Play - crunching the numbers

This is the first in a series of posts looking at the challenges faced by English clubs in complying with UEFA's Financial Fair Play ("FFP") rules. Next season (2011/12) is the first year when clubs' "break-even result" are calculated. The tables below shows what "break-even result" the seven English clubs that played in Europe this season would have achieved on last year's figures (Liverpool numbers are for 2008/09 as they have not yet published 2009/10 results).

Relevant income

The "relevant income" calculation is the simplest bit of the FFP rules. All football club revenue (which I have divided into the common matchday/media/commercial and retail split) is of course included. In addition, the profit from selling players is included too. Profit in this sense means the difference between a player's selling price and the book value of his registration on the club's balance sheet. Players that come through a club's youth system have a zero book value and thus any sale proceeds are 100% "profit" in the FFP calculations.

Income from non-football operations is excluded, except where they are based at or close to a club's ground (such as hotel or conference facilities). Chelsea's hotel would therefore be included in the income calculation, as would Manchester City's "Sportcity" redevelopment around Eastlands. Arsenal's property income from the re-development of Highbury would be excluded.

The other major exclusion, and one no doubt likely to cause controversy, is revenue received from "related parties" (effectively the owner or people/corporations connected to them) in transactions that are carried out "above fair value". This rule (described in Annex X B 1j) says that transactions with a related party must be compared to the "fair value" that would have been achieved if the transaction was done as a normal commercial deal. Any income above this "fair value" is disregarded when calculating a club's income. This rule is designed to prevent owners subsidising their club by, for example, paying £50m per year for a box that would normally cost £250,000.

Relevant expenses

The expenses element of the FFP is more complicated and less intuitive than the income side. Staff costs are included and are by far the largest element, indeed it can be argued that the whole aim of FFP is to bear down on staff costs across European football. Other cash operating expenses are included (the basic costs of running a football club), but depreciation of fixed assets is not included. This means that there is no account taken under the FFP calculation of any costs from investing in stadiums or training grounds. Owners can finance such capital expenditure without limit under FFP.

Finance costs such as interest payments are included, but not if they relate to borrowing taken on to construct "tangible fixed assets" such as stadia, training facilities etc. In the table above, I have deducted the c. £14.5m of Arsenal's £20.8m of interest costs that relate to the club's financing of the Emirates.

The interest figure for United excludes the significant one-off refinancing costs the club recognised in 2009/10. My understanding is that such costs would not be included under FFP. On an ongoing basis, United's bond interest will be around £44.5m per annum.

A vital element of the expenses calculation is the inclusion of the "amortisation of player contracts" charge, which is how the cost of transfers is accounted for.

The accounting treatment of transfer spending is one of the least intuitive elements of finance for most football supporters. In the UK, the treatment is covered by "Financial Reporting Standard 10: Goodwill and Intangible Assets". In a transfer, the asset that is being bought and sold is not of course the player himself but the player's registration. This "asset" has a finite length of course, being the length of the player's contract with the acquiring club and FRS 10 says that the cost of buying the registration must be "recognised" over that life.

So when a club "buys" a player on a five year deal for (say) £20m, the cost is recognised over the 5 years at £4m per year, this is the "amortisation charge" for that player that appears in the profit and loss account. The timing of cash payments is irrelevant. The money could be paid up front or in agreed stages but the "cost" is recognised evenly over the contract. If after (say) three years the player negotiates a new five year deal, the remaining value (£8m in this example) plus any costs of negotiating the new contract (hello Paul Stretford et al) are added together and then recognised over the life of the new contract.

By including the amortisation charge in the expenses calculation, FFP captures transfer spending over an extended period. Even if a club stops spending after a period of heavy investment, the amortisation charge will stay high for a prolonged period. The chart below shows my estimate of Manchester City's charge over the next five years assuming no further purchases or sales (other than those players currently out on loan).

Dividend payments are captured in the calculation (in order to ensure debt is not disguised as equity). If the Glazers exercise any of their dividend rights (currently around £95m), such payments would have to be included in the FFP calculation.

As with the income calculation, transactions with "related parties" not done at "fair value" are adjusted for in the relevant expenses calculation. This is to prevent owners subsidising their clubs through taking on club costs (such as directly paying players for example).

The final major adjustments in the expense calculation relate to spending on youth development and community activities. Both are excluded from the FFP numbers, meaning clubs can spend as much as they wish on these areas. I have estimated figures for all seven clubs as they are not separately disclosed in the accounts.

Income minus expenses = "break-even result"

Subtracting "relevant expenses" from "relevant income" gives us the all important "break-even result". This is the key figure under the new regulations. In the first two "monitoring periods", seasons 2011/12 and 2012/13, clubs are not permitted to make a loss greater than €45m (c. £39.5m) over these two years combined if they are to receive a licence to play in Europe in 2013/14.

As you can see from the table above, only three or the seven English clubs would have made a profit under the break-even calculation last year, and Spurs' profit was only due to profits on player sales. United would have shown a loss if the exceptional financing costs were included. The losses at both Chelsea and City stand out. The figures for Liverpool are misleading, because they include significant finance costs relating to the debt Hicks and Gillet loaded on the club which have now been cleared.

Enforcement and exemptions
Meeting the new rules is going to be hard for many clubs across Europe. A key question is the extent to which  UEFA actually enforce their new rules. The credibility of Michel Platini and UEFA as an organisation are clearly on the line, and I believe they will be enforced, although that may well mean banning a major club from European competition.

The rules do give one notable exemption to the calculations I have outlined for the first two seasons in which the rules apply (2013/14 and 2014/15), set out in Annex XI 2, the final page of the regulations. If a club breaches the "break-even" target in the "monitoring periods" for either of these seasons because of a loss in the 2011/12 season caused by wages paid to players under contracts signed before 1st June 2010 (when the FFP rules were published) the club will be let off (as long as losses are reducing over time). That is quite a big get out, and may well mean that City and Chelsea do not face the imminent prospect of a European ban. The exemption is only temporary however and the principle remains the same, if UEFA enforce FFP, many clubs are going to have to cut their wage bills and/or radically boost their revenues in the next few years.



Daniel said...

Very interesting post. The first of its kind in looking through the numbers in detail. I think that the Annex XI provisions will assist the clubs in the first two monitoring periods considerably. Just written an article from the legal perspective on the rules. Feel free to take a look

andersred said...

Hi Daniel,

I think you're are absolutely right about the Annex XI provisions (which I did mention). It is very hard to disaggregate the wage bill into pre and post June 2010 contracts of course! As I said, it only defers the evil day of course.....

Very interesting article on all the legal aspects.


Mr Parker's Dogbite said...

Good article as always but...I know it's only a drop in the ocean but I'm not sure why you estimate Arsenal and Manchester United's expenditure on youth as £10m but Chelsea's only at £8m. Seems to me that the three clubs are at least comparable on this measure given Chelsea investment in their Youth Academy. I suspect the community development figure is much higher too.

Bob said...

This ain't going to work as long as not all confederations enforce the same thing. What would stop owners of Man City or Chelsea from selling couple of players to couple of proxy club outside UEFA jurisdiction (South America or Gulf)for 30 millions and then borrowing the same player at a nominal value of say 4 millions booking a positive revenue?
Or am I overseeing something?

Anonymous said...

How do other major European clubs (Real, Barca, Milan etc) stack up?

Anonymous said...

Hello Andersred!

Thanks for en excellent blog and for your figth du enligth us Utdfans worldwide. Im on the same side of the fence like you (hatred for the Glazers etc).

I´ve a question about our noisy neigbours as we refere to them. They have obvious a mounting to climb to be able to fulfil the FFP regs. But I´ve been reading alot of stuff about their propertyproject in Manchester. In short, they are trying to bulild a hybrid version of Las Vegas with casio, hotel etc.

How will UEFA consider this, surley it cant be fotbollrelated income (for the break-even calculations)? As we speak they try to boost their turnover with a lot of stuff that you can say is NOT fotballrelated incomes. Not according to me and by UEFAs own rulebook should not count.

We all know they have "massive" problems filling their ground, even as they practical give tickets avway for free. Their only way to boost turnover is try to attrac tourist (cityproject). Its funny, they cant fill the stadium, insted they try buy tourists :)

Excuse my spelling and thanks for all excellent reading.

Btw, no 19 is comming home, I have been around since the days we had only 7 :)

Harry said...

Get your Free Credit Score Report - free for 30 Days. Unique anti-ID theft security measures included in this fantastic package as part of the service.Free Credit Score Report

Paul said...

Hi Anders, probably silly question and I suspect I know the answer, but how does paying £13.2m for a manager get addressed or not by FFP?

Read all of your fantastic blogs but when I saw this on Sky Sports News tonight in reference to Chelsea,I thought of this particular blog and wondered whether UEFA had factored transfer fees for managers as part of FFP. Although there have been buy out clauses previously, this is a virtual transfer!

Keep up the great work, it is appreciated.

Anonymous said...

So why do Chelsea, despite the losses posted yesterday, seem so upbeat that they can spend £70m-plus in the transfer window and release a statement they’re on course for FFP?

The Chelsea statement said: ‘The club is in a strong position to meet the challenges of UEFA ‘financial fair play’ initiatives which will be relevant to the financial statements to be released in early 2013.’

The reason is because they know that for the first and second MPs, namely the two-year period before 2013-14 and the three-year period before 2014-15, they will be able to deduct from any losses the amount of any players’ wages agreed in deals signed before 1 June 2010.In other words, if Chelsea’s wage bill is currently in the vicinity of £160m per year (give or take £10m-ish), the majority of that is going to players who signed their most recent deals before 1 June 2010. Let’s assume, for the purposes of this example, only half that sum, £80m, is on wages agreed before last summer.

Again, to be crassly simplistic, in the financial year just reported, Chelsea lost £70.9m but could actually write off the wages (£80m in our example) agreed before 1 June 2010. In other words, they didn’t lose £70.9m for FFP purposes, they actually made money!