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A Treatise on FFP and Football Finance

The 2011/12 football season is revolutionary in more ways than one. Not only are we seeing the rise of the next great Manchester United team under the stewardship of Sir Alex Ferguson, and not only is Joey “Nietzche” Barton now the captain of QPR, but this season represents the first in which football clubs finances come under the scrutiny of the much talked about UEFA Financial Fair Play Regulations (FFPR).

As you’d expect, FFPR is a subject that has thus far caused much discussion, controversy and confusion. Based on my jaunts to the pub and yonder, many good folk appear to understand what the general rules are (that, financially, clubs have to break-even), but beyond that their knowledge has been clouded by ignorant reporting and wishful thinking. Many City fans would have you believe that because of United’s Glazer induced debt, we have no chance of complying with FFPR, and many United fans would have you believe that, due to mass transfer expenditure by the Lottery Winners (City) in recent years, the Gorton Globetrotters too have little chance of complying with said regulation.

In most ways, both statements are wrong (more so the accusation made by some City fans), and so before delving further into the issue it’s probably worth looking at the general rules of FFP and seeing whether there is more to it than clubs simply having to “break-even.”

The first point to make is that FFPR only applies to teams who wish to play in the Champions League and the Europa League, UEFA competitions, and not to the Premiership, and that clubs with income and expense less than €5m a year are exempt. Currently, any club that wishes to take part in a UEFA competition must apply for a UEFA Club License at the start of the season, and from the 2013-14 season, a prerequisite for a club attaining the UEFA Club License is compliance with FFPR.

So as explained by the ‘On The Ball’ football report by Field Fisher Waterhouse (link here), “The FFPRs will therefore start to bite from the 2013-14 season… [so] until the 2013-14 season there are no sanctions for breaching the FFPRs.” And as summarised by the superb Deloitte Annual Review of Football Finance (link here), “The break-even requirement will first apply for the financial statements for the reporting period ending in 2012. For a club with a reporting period ending 30 June [as United’s does] this means its financial results for the year from 1 July 2011 will be the first to be assessed, for the 2013/14 UEFA competition season.”

So what financial information do UEFA take into account, what does a club have to do to “break-even”? Well, the basic premise is that a club should not spend more than the income it generates, but it’s not as simple as a club simply looking at their financial statements, deducting all their expenses from all of their income and seeing if the result is greater than £0. Some expenditure, as Man City have realised, is exempt from the calculation, and for the first few years of the legislation, some losses are allowed, with figures from several years being considered in aggregate.

As explained by the Deloitte AROFF, “A club’s break-even result for a reporting period is calculated as the difference between relevant income and relevant expenses, as defined in the UEFA Club Licensing and financial fair play Regulations…relevant income includes all revenue streams, player transfer disposals and finance income. Relevant expenses include the cost of player transfer acquisitions, finance costs and all types of expenditure by a football club except depreciation of tangible fixed assets (e.g. the cost of the stadium and training facilities), expenditure on youth and community development activities, and tax on profits.”

Now I’m assuming that, when reading that last sentence, you immediately thought of Man City. You’d be right to do so. This impressive project that they’ve planned for the area surrounding the Etihad Stadium (the Etihad Campus), which consists of several football pitches, a 7,000 seat stadium and state-of-the-art training facilities, all expenditure on it will be exempt from the break-even calculation. As I’m sure you’ve also figured out, this is to encourage investment in youth development and infrastructure, and so, as explained by the ‘On The Ball’ report, “The greater the commercial revenue growth funded by long term infrastructure investment the larger the revenue to balance against expenditure.” So in short, City are spending money on something for which the costs will be excluded from the break-even calculation, but the revenue that’s generated from these assets can be included.

And I’m sure many of you are aware that that’s not the only clever thing that City have done, there’s also the £400m sponsorship deal with Etihad, a related company, that has raised a few eyebrows in the football world. Many people raised concerns about a transaction like this taking place well in the infancy of the FFP regulations (“Can’t the owner just buy £1bn of merchandise?”), and the response by UEFA was to include a clause that states that all such sponsorship and advertising deals must be measured at “fair value,” and that transactions must be at arms-length, especially with related parties. But what is “fair value?”

It’s accounting terminology, basically meaning the price that something would receive on an active market. So let’s say that City sell a Mars bar to their owner for £1m and try book that to their revenue. Well, they aint getting away with that, because a simple trip to the supermarket would tell you that the fair value of a Mars bar is about 50p. So how do you measure the fair value of a sponsorship deal? Normally, you’d look at what similar clubs have in place. For example, if United’s shirt sponsorship deal was £10m a year and Liverpool’s was £9m, and City ended up getting one for £25m from Etihad (a related party, as City’s owners also own Etihad), eyebrows would again be raised. However, the problem with City’s deal is that it’s unique, Etihad have sponsored the shirt, the stadium and the surrounding area, and so there is nothing to benchmark this deal against.

At the start of the season I was flabbergasted by how much City spent on transfers. Due to the details of accounting standards/rules, when a club buy a player, the cost of this doesn’t go straight to the profit and loss account as an expense. Instead, they “capitalise” the value of the player, meaning that the player goes on the asset side of a clubs balance sheet as something they own, as you would if you bought a computer or a table. This capitalised player is then “amortised” over the length of his contract, with the amount amortised each year going as an expense to the profit and loss account.

For example, say City bought Nasri for £25m on a 5-year contract. They’ll have had £25m go out of their bank account, and on their balance sheet will be a player worth £25m; no expense has gone through their P&L. But each year a £5m expense does go to the profit and loss account, and the value of the player on the balance sheet decreases by the same amount. So for example, in four years time, Nasri would be a £5m asset on City’s balance sheet.

I know what you’re thinking, that’s ridiculous, because in 4 years time Nasri will be worth more than £5m. I agree, but per the relevant accounting standards (IAS38 for international accounting standards and FRS10 for UK), you can’t revalue a player to “fair value” like this because these players aren’t homogeneous products and they aren’t frequently traded on an active market.

So basically, City have bought all of these players this year, so their amortisation charge to their profit and loss account next year is going to be huge, and this is something that’s taken into account when calculating the compliance with FFPR. Unlike expenditure on the stadium or youth development facilities, it isn’t excluded. They have already made massive losses in recent years, and their wage bill (pre-Etihad deal) is >100% of their revenue, whereas United’s and Arsenal’s wage bill is around 50% of turnover (UEFA recommend a maximum of 70%).

So it seems to be going both ways with City; they’re still spending loads of money on new players (and the wages that go with it), despite their huge losses in recent years, and this will create further expenses that are taken into consideration when calculating the FFP break-even requirement. But on the other hand they’re ramping up their revenues through dodgy sponsorship deals and benefits that will flow from assets exempt from the break-even calc (the training facility), and they’re also got Champions League revenue to flow-in for this year. However, as mentioned above, something else in their favour is that they are actually allowed to make losses for the first few years of FFP.

The aggregate break-even result is the sum of the results of three reporting periods, so the first three will be 2011/12, 2012/13 and 2013/14. If the sum of these three periods results in a negative, this can be set off by a surplus in 2014/15 and 2015/16.  So if the aggregate result is a positive the club is said to have a surplus and they have fulfilled the requirements. If the aggregate result is negative, the club is said to have a deficit, but there is a tolerable level of deficit for a club.

This tolerable level is €5m, but it can be greater if, per Deloitte, “[S]uch excess is entirely covered by unconditional contributions from equity participants and/or related parties.” For 2013/14 and 2014/15, an excess of €45m is allowed (if covered per above), and for 2015/16, 2016/17 and 2017/18  it’s €30m. From 2018/19 a lower limit will be allowed, but it hasn’t yet been said what that will be, so in a way clubs won’t have to break-even until 2018/19 at the earliest.

So if a club doesn’t fulfil the break-even requirement, they may get a warning, a fine or be excluded from future UEFA competitions. Whether UEFA have the balls to do this remains to be seen; the threat is there, but City fans needn’t fear too much.

So what about United? Will our infamous debt be a hindrance with regards to complying with FFP? As stated by the ‘On The Ball’ report, “UEFA has also been at great pains to stress that they are not anti-debt. With clubs like Manchester United’s huge reported debt, Mr Platini placated various clubs with the distinction that so long as the debt is being serviced (i.e. revenue is covering interest payments) UEFA does not have a problem. Issues become more delicate when interest payments to service the debt do not cover the revenue. Prior to the latest Liverpool FC takeover, its latest accounts showed that the club’s trading profit of £27.4m fell someway short of the £40.1m required to service the interest payments due.”

This is a very important point, because the 2008 global financial crisis seems to have made “debt” a dirty word in the minds of many people, whereas in the practical world of finance, companies couldn’t survive without debt (or an equivalent). Think about it; you want to start a business selling widgets, but you don’t have enough money to set up your business. So what do you do? In simplistic terms, you have two options; you can issue shares or you can get a loan/debt, hence why someone who says the world can do without banks and financial markets is a moron of the highest degree.

Issuing shares basically means someone giving you money and you giving them a share of your business. In return they expect you to maximise the value of your business (which, in finance jargon, is done by maximising the present value of future cash flows) so that the value of the shares increases or, failing this, you give them some dividends so they can wet their beak in the short-term (let’s not go into Modigliani and Millers Dividend Irrelevance Proposition). This is so that the investor is compensated for their risk, because in the event of a wind-up, ordinary shareholders like this are the last in line to get their money back.

Getting a loan is very similar. You go to the bank and receive a sum of money off them, and in return you pay interest on that loan, again to compensate for the risk that you go bankrupt and they lose their money. Loans are more tax efficient than shares because interest payments on loans are tax deductible, whereas dividend payments are not. However, it is riskier for a company to be financed more by debt than by equity/shares because there is an obligation to pay interest on loans, whereas there isn’t an obligation to pay dividends for shares. The ratio between the two is known as a company’s “gearing” ratio.

So whichever option you choose, you use this money you’ve raised to buy your widget machine and get an office so you can make and sell widgets. You then make sure that your sales produce enough cash to pay the monthly payments (plus interest) on your loan, so that over time you pay off your loan and end up owning a debt-free business where all of the revenue will be yours to do what you want with it. At the end of the first year of trading the figures may well look terrible at first glance; your original loan may have been £1m and your sales may only be £100k, but as long as you can cover the payments on the loan everything is fine.

And this was the difference between United and Liverpool. United can afford to pay off all of our interest payments as we are a profitable business, although this wasn’t the case when the exorbitant interest on the PIK debts had to be paid. Liverpool, however, didn’t have sufficient cashflows (note, not profits) to pay their interest payments, hence RBS kicked out the two cowboys and John Henry and NESV replaced them. So whilst the Glazer’s aren’t killing United like Hicks and Gillett did with Liverpool, we’ve still had to pay north of £450m in interest payments for the privilege of them being our owners, and we didn’t need them in the first place, we were a debt free institution before then.

For more information on the financial position and performance of United, I recommend this article by Andy “Andersred” Green (link here), this article by Swiss Ramble (link here) or you can check out the figures for yourself on the Man United Finance plc website (link here).

So we know what FFP is, we know how it works, and we know how it affects United and City. But why did UEFA do it? Why did they feel that they need to set down laws and regulations that, using incentives, try to make clubs be financially responsible and not spend beyond their means? The ‘On The Ball’ report puts it pretty well:

“UEFA has implemented, as part of its already functioning club licensing system, the FFPRs to ensure a club in the longer term, more or less, has to break even. UEFA’s overall aim for the FFPRs is for its affiliated football clubs to balance their books, not spend more than they earn and promote investment in their stadia and training facility infrastructure and youth development. This idea of self-sustainability relates to UEFA’s underlying belief that transfer fee and wage inflation continues unabated because each set of new club owners inject more money into the European football club market. This ‘keeping up with the Jones’s effect’ spirals further because a new owner then has to outbid other high spending clubs.”

In short, clubs need saving from themselves, and this is what they’ve asked UEFA to do. Football is unique in two particular ways; the first is that, unlike in business, not everyone can win. Although many firms in a particular industry may compete with one another, there is still a way in which they all win, which is by making healthy profits. Sure, some will make larger profits than others, but all will go some way to achieving their goal of profit maximisation, and their shareholders will on the whole be happy. In football, however, there can only be one winner; one team win the league, one team win the Champions League and one team win the FA Cup. In one particular year, however, the same team won all of these.

So despite how well a team may have played, how close they may have come to success and how effectively they may have spent their money, their main stakeholder, the fans, will not be happy if there isn’t any silverware to show at the end of the season (see Arsenal). The profit figures for teams in the Premier League show that it is the mid-tier clubs who a struggling financially, borrowing money and spending this on players in an attempt to break into the top-four/six so that they can earn that revenue that will pay off these loans and then use this platform as a springboard for future success. The problem is that there are only so many European places up for grabs, and when more clubs try this strategy than there are European places, there are logically going to be losers. Anyone who has ever read a book on football history will be well aware of this; this isn’t a modern phenomenon, clubs spending beyond their means in the pursuit of glory has long been a feature of the game. But why would any club buck the trend when they don’t know if others will follow? Hence why they need to be made to be financially responsible via rules and legislation from up high.

The other unique feature of the football industry is that, unlike the “normal” business world, it doesn’t help to kill off your competition. As much as we United fans may hate Liverpool and City, we still (more or less) need them to stay afloat. In a way, playing your arch rivals is a clubs raison d’être. When a club such as Plymouth is on the brink of bankruptcy, it is a tragedy for all of football, and not something that any club wants to see. Hopefully, when the big clubs are making decent profits, they can support their lower league brothers for the good of many communities all over Europe.

But to finish from a United perspective, as this is a United blog, FFP is going to help our club. Think about it, who have been the two biggest threats to United in the Premiership in the past couple of years? Chelsea and City. And how did they get to their current position? Sugar daddies. And will any club be able to spend on the scale that they have done the last 6 years? No! PSG are trying, they’ve spent a net of approximately £72.7m this summer (mainly on the sublime Javier Pastore), but the sums spent by Chelsea and City in recent years dwarfs that figure. As explained by Football Economy (link here) “France has its own domestic version of FFP, the Direction Nationale du Controle de Gestion whose rules are in many respects tigher than those of Uefa.”

PSG, however, have the advantage of being the only major team in one of the biggest cities in the world, and, along with other teams in France, may be in-line to receive a free stadium from the Government due to France being the hosts for the 2016 European Championship.

But let’s not get started on conspiracy theories, eh?

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9 Responses to “A Treatise on FFP and Football Finance”

  1. Sapper says:

    I think you forgot to say that transfer expenditure is spread over the the term of the contract, so Nasri bought for £25m on a five year deal equates to only a £5m expenditure per year.

    By the same terms City’s £400m 10 yr deal, is calculated by UEFA as only being worth £40m per year over the term of the sponsorship, and that is how they have got round the “fair value” rule

    Any player bought under the age of 21 is also not calculated according to UEFA, as they are classed as investment in youth.

  2. Thomas Addison says:

    Regarding Nasri, that’s exactly what I said. “For example, say City bought Nasri for £25m on a 5-year contract. They’ll have had £25m go out of their bank account, and on their balance sheet will be a player worth £25m; no expense has gone through their P&L. But each year a £5m expense does go to the profit and loss account, and the value of the player on the balance sheet decreases by the same amount. So for example, in four years time, Nasri would be a £5m asset on City’s balance sheet.”

    Regarding City’s £400m deal, I’m aware it was over 10 years, hence £40m a year. Doesn’t mean they got past FV because of that, they got past FV because it’s a unique deal.

    Wasn’t aware of your last point, cheers for that, is that on the UEFA FFP documentation?

  3. M16 0RA says:

    Sapper – any player bought under the age of 21 most certainly WILL be included in the calculation. UEFA allowing investment in youth means investment in infrastructure, academies, training, competitions. It doesn’t mean that a club can go out and buy Barcelona’s under 16 team and have the cost excluded from their books.

    Also although investment in infrastructure such as a training ground can be exluded, the running costs are not. So City have also got another new fairly large chunk that will come straight off their bottom line, to pay for all staff and expenses including rates, utilities etc, for an 80 acre, close to city centre, training ground.

  4. Thomas Addison says:

    Cheers for your comment M16 0RA, good point. I’m not 100% sure that the running costs of the youth development centre will be included, but based on the following explanation of relevant expenses from the Deloitte report:

    “Relevant expenses include the cost of player transfer acquisitions, finance costs and all types of expenditure by a football club except depreciation of tangible fixed assets (e.g. the cost of the stadium and training facilities), expenditure on youth and community development activities, and tax on profits.”

    I imagine that they will be included, as they’re basically general operating costs rather than exceptional costs on community development activities.

  5. Frank Scicluna says:

    Many thanks Tom. Football finances usually leave me cold but this was in simple language and easy to understand. Well done

  6. Tom Addison says:

    Glad I could help, mate. I’m not going to make out that I know everything on the matter, but I hope that helps.

  7. Sapper says:

    On the youth question, any player bought under the age of 21 is classed as youth, if they are with the club for five years prior to age 21 they are classed as “home grown”, and as I understood it do not come under the FFP rules.

    If someone knows better please correct me

  8. ChrisW says:

    Excellent article. But I am still unconvinced about this FFP stuff. The proposal to (eventually) tolerate no losses seems impractical given the fluctuating fortunes of football clubs. In particular it is often reckoned that qualification for the Champions League is worth £40m. So how can a club like United budget for the possibility of failing to qualify for the CL and other variations in income? Do they have to normally run a suplus of £50m just in case things go wrong? Otherwise, failure to qualify would lead to a loss which would result in their banning from the following years CL competition, which would result in a further loss, and so on. The only way out would be a sale of players to make the books balance and allow them to be considered for European competitions in the future. But, of course, such a weakened team might not be capable of qualification.

    This is all very artificial. The sensible way to run a club like United is to only run a modest surplus but to bank profits from the good years to pay for occasional losses if things go wrong. But FFP doesn’t have any provision for this, each season (or group of two or three seasons at the start of the scheme) is considered in isolation and must not be loss making.

  9. RedScot says:

    I think I to read this when ma brain is no satuartated wif bordo wine.its bound to be more sensible.
    once you kill a cow, you gotta make a burger!.
    jokin aside if its written bye the fabulous Tom Addison, i will read thouroughly, word bye word! As for that waste of space ‘boss’ Frank’ he is gonna getit, I am a fair weather supporter, been reading about Citeh.

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