Monday, October 02, 2006

City's Finances (Part Four)

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 Profit & Loss Accounts

This is the fourth article in the series but the first to focus on the actual financial statements, again using the 2005 accounts for illustration.

However, before that I have to point out that I made an incorrect assumption in the previous article, when I mentioned that we had £7m in our account and that it was probably the extra £7m introduced by Wardle. It turns it I wasn't quite right and thanks to the person who pointed this out (I think you read MCIVTA so you know who you are). I will explain the actual scenario in the next couple of articles but it really highlights the true state of our current finances.

The P&L account, quite simply, is a statement of our income and expenses for the year in question. There's nothing terribly complicated about it - take the expenses from the income and that's our profit or loss for the year. We can all do the same, looking at our income and subtracting our expenses such as mortgage or rent, gas and electricity, etc.

The first issue is, however, what expenses can we take? The second is that making profits, although desirable, does not necessarily tell the whole story because some of the key items are accounting rather than cash transactions.

What does this mean? Well if you buy a pie and a pint at the ground and hand over £4, that's a cash transaction, as money has changed hands. You've got £4 less and the catering outlet has got £4 more. (You've also got a gassy pint of liquid and a lukewarm concoction consisting of some of the less appealing parts of a dead animal but that's by-the-by).

However, if the outlet runs out of pies and gets some from another outlet that has plenty, that doesn't affect the number of pies in total or the total takings but both outlets would have to account for these. Otherwise their takings would appear to be wrong as one would have appeared to have sold all their pies but didn't have enough money and the other would appear to have too much money. So the transfer of the pies would be an accounting transaction.

In addition, there are ways to make the profits appear larger or smaller, depending on the way you account for some things. One example is the value of any stock you have at the year-end. The higher you value this the higher the profit will be. However, stock is not a great factor in the City accounts.

Another thing to bear in mind is that these accounts, in common with most others, are prepared on an "accruals" basis. This means that a transaction that relates to this financial year is shown, even if we haven't paid for it at the year-end. Therefore it we take delivery on a van-load of pies close to the year end, they will still appear as an expense in the accounts even if we don't pay for them until after the year end.

This also applies to items we might pay for in advance so if we pay council tax in full in April, with our May year-end two months will be shown in the current financial year but most will belong to the following financial year.

The same applies to season ticket income. We collect most of that before the year-end but it isn't accounted for until the following year because it relates solely to the next season, which is covered by the next year's accounts. I'll talk about this in the Balance Sheet article.
But to get back to the 2005 accounts, you will see that a number of different figures appear for our profit or loss. There's the Operating Profit, the Profit or Loss after Amortisation, the Profit or Loss before Interest. Some show a profit and some show a loss. So which is the right one? Well they all are - there is a standard way of reporting these things that leads to all of these as I'll explain.

The first figure in the P & L Account is turnover of £60,864. This is actually £60 million, as the figures are shown in thousands to make them more readable. Next to it is last year's figure (£61,932) and if we look at Note 2 on Page 23, it tells us how these are broken down. In 2005 £15,073 (£15m) was gate receipts, £26,143 was TV income and £19,501 was described as Other Commercial Activities. This is probably match day hospitality, shirt and other sponsorship and income from both the other sporting and non-sporting use of the stadium. There is also a (relatively) small contribution from the development association.

The first thing that is clear from all this is that the ordinary supporter, either with a season ticket or paying on the gate, is the least important of the three major income streams. TV and other commercial income combined bring in three times more than gate money. However a good cup run or European football does make a difference as they can bring in well over £1m per home game before any TV money is taken into account. We had neither in the 2004/5 season and even though we had a decent league finish, our gate receipts were significantly lower because of that. TV income I believe includes the so- called Merit Money for league placement.

The next figure is Operating Expenses of £57,359. This is in brackets as it needs to be subtracted from the Income figure. It is pretty similar to last year and the first group of figures in Note 3 shows a more detailed breakdown, with a summary at the end.

The biggest single item is (surprise, surprise), staff costs of £37,677. Note 4 shows the split between staff and player numbers (but not wages) but you can clearly see that to reduce costs to any great degree involves reducing the wage bill. These wages include the cost of Keegan's departure and that could have been up to £2m. This, together with the loss of some higher earners at the end of the 2004/5 season should lead to a significant reduction in wage costs for this last year. I would be expecting just over £30m in the forthcoming accounts. The proportion of our income spent on wages is a key measure for football clubs. In our case, in this year it works out to 61.9% and in practical terms means that if you pay £500 for a season ticket then over £300 of that goes out in wages. This is about the average for the Premiership over the last few years.

There is plenty of football research suggesting that the higher your wage bill the better you do. This is hardly surprising as bigger squads of better players (who will be paid more) should out-perform smaller squads of less well-paid players over time. However, one club spectacularly bucked that trend last season and despite having one of the highest wage bills, finished in the bottom six. No prizes for guessing who it is!

Note that the Operating Expenses does not include any expenditure on transfers or debt interest. It only relates to the direct expenses of running the club and the stadium. This gives us an operating profit of £3,505 (that's £3.5m don't forget). This is fine, as the wage bill alone outstrips income at some other clubs. However, from a profit point of view that's not the end of the story.

The other part of our operating expenses comes under the heading of depreciation. You've all heard of this - if you buy a new car it depreciates as its value goes down year on year. Therefore depreciation can be summed as a measure of the loss of value of an asset over time. It's an accounting transaction as we don't actually put the cash aside and can be looked at as a charge for the use of that asset during the year. Note 1 shows the depreciation charge on various types of asset. So the 2% charge on Freehold Buildings means that we expect these to have a useful life of 50 years because it will take this long at 2% per year to write the whole cost off.

Similarly we allow only 4 years for Computer Equipment as we write off 25% of that each year. "Straight Line" means it is applied to the original cost so if we buy a computer for £800, we would charge £200 depreciation on that for each of the next four years. The depreciation on our business assets like buildings, fittings and computers is included in operating expenses.

The same concept applies to players, except it is called amortisation. It has a slightly different meaning in theory but for our purposes is the same thing. Therefore if we sign a player for £6m on a 3-year contract, we charge £2m amortisation to the accounts for each of those three years. The large figure of over £11.5m in the accounts reflects our high expenditure on players over the last few years. However, we only charge amortisation for transfers in and while the player is still on our books so the combination of Bosman signings and Academy players won't attract this level of charge in future accounts. However, adding in this charge in these accounts reduces a
£3.5 million profit to a loss of just over £8m. However, it's important to remember that we've not actually paid money out in respect of depreciation/amortisation, even though it's turned a profit into a loss.

The next group of figures include the profit or loss on disposal of fixed assets and players and it's important to be aware of how this is worked out.

The book value of a player at the time we sell him is not his cost but his cost less all amortisation charged on him (and this could include a part charge if we sell him part way through the financial year). Taking the example of a £6m player on a three year contract, we have already said we would charge £2m per year. Therefore if we sell him at the end of his second year for £3m it looks like, on the surface, we have lost £3m. However, in accounting terms we have actually made a profit of £1m. How come? Well, we've charged two lots of amortisation (2 x £2m) which totals £4m and this reduces his accounting value to £2m (£6m cost - £4m amortisation). So this explains how the club can claim we made a profit on the sale of a player even though we got a lot less than we paid for him. This means that the sale of SWP, who cost us nothing, will generate a huge profit in the 2006 accounts. The small profit we show in these accounts reduces our overall loss from £8,060 to £7,721.

The next group of entries relate to interest, both payable and receivable and something called Stadium finance lease charges. As we are in debt, we obviously pay more interest than we receive. It also, as far as I'm aware includes the interest that has been added to the loans from Wardle and Makin, whether or not we actually pay it to them. The charge for lease interest represents the interest that we believe would have been charged if we'd borrowed the money and is part of the actual payments we make during the year. The actual lease payments are not themselves expenses, just the interest element and likewise for other loan repayments and bank interest.

Notes 5 & 6 are not desperately illuminating as all they do is split out bank interest from total interest on our other loans.

The subject of tax is very complicated but suffice it to say that, with our losses, we pay no tax. The last figure of loss per share (or earnings per share if we make a profit) is explained in Note 8 and is a key measure used by financial analysts but is more useful for companies that pay a dividend on their shares.

What does all this mean at the end of the day? Well, we've made a loss of over £15.5m but that doesn't mean we've spent £15.5m more cash than we received in income. £11.5m of this, for example, was for the accounting entry relating to amortisation and no cash is involved. We can see what our income is, how it is split and how much we pay in wages. We can also see what our overall interest bill is. So we can get some idea of where all the money goes and it partly answers the question that people often ask "How come with one of the biggest incomes in world football we never seem to have any money?"

However, it doesn't tell us how much net cash we generate or what our overall financial state is.
In the 2006 accounts our profits will presumably be pretty impressive but much of this will be down to the £21m received for SWP, which should be pure profit. The salient figures will be our income, in which a decent cup run was negated by a fifteenth place finish. So there's probably not going to be much change there. The wage bill should be reduced and it will be interesting to see by how much. Amortisation of players should also be a lot lower. So even without the SWP sale, I would expect we should be close to an overall profit.

But that doesn't mean much in itself although the club PR machine will undoubtedly focus on it.
In the next article I'll attempt to explain the Balance Sheet and this, I think I can promise you, will make very interesting reading.

Colin Savage


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