City's Finances (Part Five)

This is the next part in a series of articles written by Colin Savage first published in MCIVTA's newsletter with reference to City's Finances. With the permission of Colin and MCIVTA (thank you Heidi) it is re-published here. I think you'll find this to be another informative, interesting and factual article.

THE BALANCE SHEET

In the last article I looked at the Profit & Loss account and explained that this is a summary of our income and related expenditure over the financial year. Once the year is finished and the books are closed then we start again. The balance sheet however represents a snapshot of the financial situation at any point in time and is therefore far more revealing of the true state of the club's financial health. It details our assets (the things we own) versus our liabilities (the things we owe). When you hear about companies becoming insolvent and going into receivership or liquidation, it is generally because they owe significantly more than they could pay, even if they sold all their assets, and are never realistically likely to remedy the situation.

To give you an analogy, if someone earns £20,000 a year and spends £19,000, then you would think that they were OK. However if you then discovered that they owed £50,000 on credit cards and loans then you'd realise that they were actually in a mess, particularly if their expenditure didn't include any repayments or only included token ones. So, as I said in the previous article, profits or losses alone are not the be-all and end-all. You need to look at the full picture.

The balance sheet is split up into a number of different sections: There are sections on fixed assets, current assets, creditors (short term & long term) plus capital and reserves.

FIXED ASSETS

These are assets that have a life of a few years or more and are split between Tangible Assets and Intangible Assets. The former are the land and buildings, their fixtures and fittings plus any other equipment. The latter are the players. Now I know that the word "asset" when applied to some members of the playing staff makes strange reading but that's what they are.

The values shown for fixed assets (£11m Intangible Assets and £156.8m Tangible assets) represent their original cost less any accumulated depreciation, which I talked about in the last article. Notes 10 & 11 in the 2005 accounts give more detail. One bit of jargon to note - when costs are "capitalised" it means that cost is treated as a fixed asset rather than an expense. Therefore it will be added to assets in the balance sheet rather than being shown as an expense in the P & L account.

The note shows the original cost of the players as at 1 June 2004, plus the cost of any additions, less the original cost of any player sold in the period. As at 1 June 2004 our playing staff had cost a staggering total of just under £55m! That, you have to remember, is only players still on our books at that time, not every player we've ever bought. The next figure is the cost of any additions to the squad (£1.3m in this case) and then the original cost of any players sold during the year (£19.75m). Clearly, the man who hopes to play in the Champions League for Bolton (pause for rolling on the floor with laughter) is the major element of this.

The final figure in costs of £36,395 (that's £36m) is the original cost of the players we had left at 31 May 2005. I know what you're thinking - Fowler and Macken come to mind but how the hell is the rest of that made up? It's not about value, just about cost.

The next section shows the amortisation in a similar fashion so at the end of the period we have the total accumulated amortisation for players still on our books. Taking the latter from the former gives us £11m. This is the accounting value of all players that we have bought so SWP, Richards, Onuoha, etc, are not in this figure. If you look at Note 1 on page 21, you will see a paragraph on intangible assets. The last sentence talks about "impairment" and means that if the club believe a player's real value is less than their book value then this should be provided for. This would be shown as an expense in the accounts. Presumably this would relate to a career-ending injury or something similar, not the fact that no manager in their right mind would touch them with a bargepole even when fully fit. No manager, that is, apart from the one we had at the time.

The tangible fixed assets follow the same pattern but are split by type of asset. The major item here is the stadium lease under Land & Buildings (Long Leasehold) and I've covered this in a previous article.

CURRENT ASSETS

Separate to the fixed assets, these are assets that are short-term. In the Balance Sheet they are split between stocks for re-sale (things like food and drink and the stock in the stores), debtors (money we are owed) and cash we hold, both in the tills and our bank. You will notice that our bank balance is seemingly much healthier than the previous year. That's nothing to do with the superb way the club's finances have been managed unfortunately. I've covered this in more detail under Creditors.

Note 14 on page 29 talks about prepayments and accrued income and this represents items we've paid for upfront during the year but relate partly to the following financial year or income we are due that has not been invoiced by the year end (e.g. rent the club may charge but isn't due until a later date). We still have to show that we have earned a proportion of this even if we haven't received a bean for it as yet.

CREDITORS

The first figure (amounts falling due within one year) is our short term liabilities, i.e. monies we owe to others within the next 12 months. These are detailed in Note 15 (page 30) but the main items of interest are, once again, related to directors' and other loans and these have been covered previously.

The Balance Sheet then shows a total for Net Current (Liabilities)/Assets. (This means that, if the figure is in brackets it is a net liability and, if not, a net asset). It shows the gap between our stated assets and the stated liabilities and is calculated by adding the value of fixed assets to current assets and subtracting current liabilities (Creditors falling due within one year). In other words, if we sold all our fixed assets for their book value, collected all our debts, sold all our stock at cost and used this to pay our creditors then how much of a surplus, if any, would we have.

The second group of Creditors are our longer term liabilities, i.e.
those who are due to be paid in more than one year. Once again it's mainly loans, the lease and some longer term creditors. We can ignore the lease figure as it is purely notional but that still leaves over £50m of loans and trade creditors that have to be paid back.

The figure for Deferred Income is very interesting. This relates to income we've received that doesn't relate to this year but a future year. Note 18 on Page 33 reveals that £4.5m of this relates to some grants we've received and are spread over a number of years. But what is the £16m? It took me a little while to work it out but I'm now pretty certain that most, if not all of it, is season ticket receipts. We have to renew our tickets by April at the latest, which is ludicrously early compared to other clubs. So the club has taken up to £16m in season ticket money but can't show it in this Profit & Loss account as it relates to the next financial year. (I also believe that it includes VAT, which is not included in the figure shown in the P & L Account).

You would expect, therefore, that our bank account would therefore be very healthy, having taken in this money on top of our usual income from ticket sales, TV and other activities just before our year end but it isn't. It certainly contains over £7m so that's not too bad, you might think. I said in the previous article that it was the obvious conclusion that this is the £7m introduced by John Wardle. However, some intriguing information I came across on an online forum leads me to believe that I was wrong. It would appear that, following a court decision in 2005, any assets that are pledged as security have to be "ring-fenced" (kept separate) from other assets.

In our case this refers to season ticket income that we use for security against the long-term secured loans. We have to keep the portion we need to pay the debts separate and can't use it to pay operating expenses or to buy players. Last year we were able to use that income but can't this year. Hence we have a large sum in the bank. The problem is that we need that money because (as I will show in the next article) our cash flow is probably at its worst around February and March, which is why we are heavily encouraged to renew season cards then. And, believe me, if my estimates are right, we need it badly. So to make up the deficit, it would seem that Wardle had to put in that "lost" £7m in order, presumably, to keep us solvent.

The final section of Creditors is Capital & Reserves and the first two figures in this should represent the total proceeds of any share issues. Note 19 on Page 33 shows that the face value of our shares is 10p and just over 54m of these have actually been issued. The note also shows that there are another 10m shares not issued. However the face value usually bears no relation to the issue price and the difference between the two is put in the Share Premium Account. Doing the arithmetic shows an average share issue price of just under 60p per share. The market price is less than half of that so anyone who paid 60p per share or thereabouts, is sitting on a significant loss.

The revaluation reserve relates to the stadium. This, I think, should mainly represent the difference between the current value of the stadium, less the value of Maine Road and the value of future lease payments on CoMS. So if we valued CoMS at £150m, Maine Road at £35m and the future value of lease payments at £35m, this reserve would be around £80m. The value of CoMS will change over time and this reserve will change in line with its value and the estimated value of future lease payments. It does not represent cash in the bank but it is purely an accounting transaction to cover the increase in value of CoMS, compared to Maine Road.

The final figure shows the accumulated profit or, in our case, loss over our financial history. The annual profit or loss in the year is added to the balance at the end of the previous year and you can see this in Note 20 on Page 34. The total of these figures under Capital and Reserves is the same as Net Assets (£28,527), which is why it is called the Balance Sheet as our assets should balance with our liabilities. Any surplus of assets over liabilities belongs to the shareholders in theory.

So if you or I sold our house, paid our mortgage off, cleared our credit cards and overdraft and paid our household bills then we would hope to have something left over. Clearly, the more we have left over, the better off we are. However, if we can't meet all these liabilities from the sale of our assets then, as I said earlier, we're in a mess.

Let's extend this to Manchester City and assume that it ceases to trade. We would have to sell all our assets and pay off all our liabilities. If we could do that then we could safely say that our financial situation is not too bad. If we can't then we have to be worried. So Manchester City should be alright as they've got net assets of over £28.5m.

Except it's not quite that simple (it never is where City is concerned of course). For one thing there is the lease and around £140m of those assets relates to the valuation of the lease on the stadium. However, as you saw if you read the article about the stadium, we don't own it. Therefore in practical terms it is difficult to put a practical value on it.

If we take this asset out then the net asset picture is not quite as healthy. However to balance this let's also assume that we would have no further liability to pay the lease and the total value of this is £42m. So we can take £98m out of our assets. Overall then we seem to be about £70m short of being able to pay our debts from our assets.

However football clubs are different to most other businesses in a few ways and the main one is how they value their players. As you've seen, we only put a financial value on players we've bought and that only relates to the amount we paid for them less amortisation. So we've only got £11m for players in the balance sheet but SWP (who wasn't part of this £11m) was sold for £21m a few weeks later. So let's value our players a bit more realistically. We could argue about this all day but including SWP, I've come up with a value of £61m.

So that's £50m more assets than we've accounted for. So without the lease we are probably £20m short of being able to meet our liabilities, although the lease may well have significant value, if we were able to sell it. However that will depend on whether we have the right to do that or whether the council simply takes it back. Now I don't know the answer to this and have seen a lot of postings on City forums giving many different opinions but nothing to confirm the situation one way or another. Interestingly, both the club and the council seem to be very coy about the exact terms of the lease. Hence the desperate need for the board to strengthen the Balance Sheet. * See note below.

The problem is that, to do this, we need to make profits and generate cash. This means that we need to increase income and assets or, more realistically, reduce costs and liabilities. Reducing costs means reducing wages and or debts and involves less money for transfers. This in turn, means less likelihood of achieving anything significant on the playing field. Another way of strengthening the Balance Sheet is to sell an asset for more than its book value. The only assets we have that we could use in this way are our young players who, because they cost us nothing, have no book value at all. But we wouldn't sell a good, young player just to strengthen our Balance sheet would we?

In the final article I'll look at the Cash Flow Statement. This is another way of looking at where the money goes but is more relevant to us than the P & L account. I'll also deal with what I see as our general cash-flow situation and why I believe we have to renew our season tickets so early.

* However, I have to stress that this is just a hypothetical and very simplistic scenario and does not mean that we are in imminent danger of going bust. What is does mean, however, is that if my analysis is correct, any major interruption to our cash flow could put us in trouble.

In the event that the worst were to happen then, if the pattern of other clubs was followed, a new company would probably be formed to buy the assets of the old one, which would include the lease and the football club. However, I couldn't say what the situation with the secured loans would be and whether the new club would need to repay them. Let's hope we never find out.