City's Finances (Part Six)

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.

Cash Flow

This was going to be the last in the series but my original draft, including a summary, proved too long. Also it was suggested that I did a separate article giving some pointers as to what to look for in the 2006 accounts. So I’m going to combine that with a summary of the finances in one final article. In this one, I’ll talk about the last of the three financial statements and what it says about our ability to finance major player purchases. I’m also going to summarise the overall cash flow situation as I see it, as this seems to me to be the most illuminating evidence about our real financial state.

The Cash Flow Statement

The Cash Flow statement seems the most obscure of the financial statements. The P&L Account shows our income and expenses, the Balance Sheet shows our assets & liabilities. But what does this show?

In Article 4 (the P&L Account) I said that this was a mixture of cash items and non-cash, accounting transactions (such as amortisation of players). The resulting profit or loss is meaningless to a large degree in a football club as the most important element is actually pure cash. The Cash Flow statement removes those non-cash items so we can see how much actual cash we have either generated or spent overall. So we need the cash flow statement to show us whether we have surplus funds available for transfers or whether we can only finance incoming transfers by selling or borrowing.

Any business (or individual) that consistently spends more cash than they earn will eventually end up in deep trouble. They will need to borrow more and more money just to keep going day-to-day, which becomes more difficult to repay. So, as I said, profits alone are meaningless unless they generate cash as well. Football clubs tend to operate to different rules, with chairmen and directors expected to pump funds in to keep them going.

The first figure in the statement shows something called Net Cash Inflow from Operating Activities. That is the amount of cash left over after we’ve paid all our operating costs from the income we’ve received. This is calculated in Note 25 and starts with the Operating Loss after player amortisation of £8,060 (£8m). The non cash items, such as amortisation and depreciation are added back and some other figures are added or subtracted relating to the overall change in stock, debtors (money we are owed) and creditors (money we owe). This gives us a cash inflow of just over £6.6m.

So can we spend this on players? Unfortunately not as it didn’t include interest paid so we have to knock off this. The P&L will show what we should have paid but you already know that we don’t actually pay the interest on the Wardle & Makin loans. So only the actual interest paid is taken into account, less any interest received. In total this comes to just under £6.7m and this wipes out the surplus from operating activities.
So here’s conclusive proof that there’s no money for new players unless we sell first. It’s not the board being skinflints and holding onto a big pile of cash to reduce the debts, it’s not lack of ambition, it’s simply lack of cash.

The next section shows this, with the cash element of the purchase and sale of assets (players and fixed assets). You will see from the Cash Flow that we received just over £8m for players and paid out £6.2m, with just under £1m paid for other fixed assets.
This gives us a small overall surplus of £899,000, so you might think that there’s nothing too wrong with the finances overall, except that we’ve still got more cash to pay out. We’ve taken into account the interest paid on loans but not the capital element and this comes to just over £4m. So the overall position is that we are over £3m short of the cash we need to get by, even when we’ve balanced our player sales and purchases. New debt issued of £10.7m, includes two things. The first is certainly the extra £7m lent by Wardle while the second, as far as I understand it, has to do with the increase in the value of the stadium lease in our accounts, due to a recalculation of the overall liability. But it could be something else entirely.

So, overall, the cash position has increased by £7.6m over the year but pretty well all of this has been introduced by the chairman, via his additional £7m loan. This means that we have actually generated no cash by our own efforts. This is a pretty similar story to the last couple of seasons. The outcome in all this is that we need to increase income and/or reduce costs. Increasing income involves consistently high league finishes, cup success and European football. Reducing costs means reducing wages and that’s certainly one part of the board’s current strategy but there’s always the risk that they get reduced to the point where we find it difficult to continue to compete at the top level. And if we lose the level of income that comes with our Premiership status then we really are in a downward spiral. So who would swap places with Wardle and Mackintosh knowing this?

Our General Cash Flow

The Cash Flow statement summarises the movement of cash over the whole year but in doing these articles I became interested in the month-by-month cash flow. Saying we have come out even over the year is one thing but what happens during the course of that year? There were a number of things that puzzled me such as why do we have to renew our season tickets in February and March, well before the current season has even finished. Why did John Wardle have to introduce a further £7m when, according to the Alistair Mackintosh interview in Accountancy Age “…the business generates significant amounts of cash…”?

Apply this to your personal finances. If you earn £2,000 a month on the 1st and spend £2,000 over the same month then your cash flow looks OK, if not particularly inspiring. However, if you’re £2,000 in the red at the start of the month and your £2,000 just puts you level before you even spend a penny then you could be on thin ice if you have an unexpected bill or the income stops for some reason. So which one is City?

It’s a trick question actually as the answer is neither of these. We appear to be like the person who starts with nothing in the bank, gets £2,000 in every month and spends £3,000. However, we also know we’ll get commission but that is paid annually, in arrears, based on what we’ve sold. So at the end of the year we’ve built up a £12,000 overdraft but we get a £12,000 bonus to clear it. And so we start again, relying on the fact that we’re going to get another £12,000 in a years time so, instead of cutting our spending to £2,000 a month and putting the bonus in the bank, carry on regardless. Clearly there are even more dangers in this scenario.

Our bonus is called Sky’s money. I’m indebted to the poster on one of the City forums who gave me the information I needed, relating to Sky payments. As far as Sky is concerned, we get the bulk of the income in a lump sum in August, as the season starts. There is an equal payment to all clubs then totalling around £15m, with the so-called merit money being paid in May, depending on league position at the end of that season. Other payments are made per game televised.

Then there is ticket income and commercial income. Much of the ticket income (an estimated £12m) is in season ticket renewals and therefore will mostly come in February, March & April. The rest of the ticket income is spread over the season. The commercial income will probably be higher in the season but we will still get some in the close season as well.

As far as expenses were concerned these will probably be higher per month in the season than the close season, as we employ more staff as well as paying appearance and (occasionally) win bonuses.

Putting all this together showed that, starting from June we were at our worst position by April and significantly in the red. My figures, I have to stress are intelligent guesswork without access to the books but would indicate that we would be overdrawn by possibly well over £10m, ignoring any season ticket income. This would therefore explain why we were so desperate for fans to renew season tickets then, when most clubs ask for renewal in July. It also explains why John Wardle had to pump in more money, after we had to keep secured assets separate (see last article).
Quite simply, if I’m anywhere near right we desperately needed that additional £7m at that time.

This begs one intriguing question; suppose in February and March we are in, or close to, the bottom three places. Would you renew your season ticket at Premiership prices if you thought there was a reasonable chance of watching Championship football? I’m not sure I would and if most people thought the same way then the impact could be potentially disastrous, with little cash coming in at the time we needed it most. Let’s face it there were a few thousand who didn’t renew at Premiership prices to watch Premiership football this season.

While I was looking at my crude cash flow forecast, I looked at what the impact would be if we renewed in June & July. This was a bit of a “Eureka”
moment as the impact of the merit money in May, added to season ticket income in June & July, with the main Sky payment coming in August, transformed the picture and produced a substantial cash pot that lasted throughout the financial year, going just overdrawn in April. It was the equivalent of getting your bonus at the beginning of the year and gradually spending it throughout the year. But at the moment it looks like we’ve effectively run out of cash by Easter. So to ensure we were on a sound financial footing, any investor would probably have to provide something like an extra £15m in working capital, on top of any funding for new players, any debt repayment and purchase of shares.

At the beginning of this series I said I had no smoking gun or insider knowledge about City’s finances. However, when I started them I firmly believed that the board were actively managing City’s finances over the next few years so that we could be in a position to compete, after a few seasons where we had to settle for mid-table mediocrity. However if the above is anywhere near correct, then I have to conclude that we’re merely running to stand still and hoping, like Dicken’s Mr Micawber, that something turns up. The new Sky

In the positively final article in this series, I’ll summarise everything and try to give you some pointers to what to look out for in the 2006 Annual Report.

Colin