Minority Report 2019-20 - Talking Finance (3)

The Financial Shock of Relegation


This is the third article in a series about football clubs and finance. The first article showed how football clubs are a separate legal entity from their owners and directors and shows how refinancing a football club which is losing money has to be done through share capital or loans (debt). The second article summarised the financial statements of all 24 Championship clubs and illustrated how much they are in debt, how the owners are financing that debt, and how control of player pay is still not being exercised. This third article looks at the systems that the EFL has introduced to try to level the financial playing field, and how a significant gap has opened up between the top 2 leagues and the lower 2 leagues, partially because of the two different control systems that are being used.


Something that I have always struggled with is this. How do clubs that move between the Championship and League 1 manage to adhere to the change in EFL financial control systems? How do they reduce wage costs when they are relegated in order to comply with SCMP? How do they attract the players that they will need when they are promoted to the Championship in order to be able to compete? After all, the difference in financial resources required for the two divisions is now huge and the likelihood of relegation in that first season back there is better than 50:50.


This piece is not about how much money our owners have, or do not have. It is not even about how much of their fortune they should be prepared to spend for the fans’ entertainment and gratification. This is just about EFL rules that cover the two leagues, and the huge gap between the leagues that those rules have created. If I am honest, that gap is now so large that it looks like it may be the precursor to the end of promotion and relegation between the leagues.


The Championship is governed by FFP. Without getting into the small print, this basically states that clubs are allowed to lose £39m over 3 years (£13m per year). There are no controls on debt, and by the looks of things, there are no controls on selling assets to controlled individuals/controlled companies, or trading between members of the same controlled organisations at prices well above market rates. Actual losses of Championship clubs can often be far higher than those reported by annual Financial Statements, because so much is hidden by the transfer of those losses to other organisations within the control of the same ownership. When they took over Barnsley Football Club, our owners said that they had looked at other clubs in the Championship, and they were all very badly run as compared to Barnsley Football Club. They said that they did not want to operate like that. My recent summary of the financial results for all Championship club bears out their assessment.


League 1 is governed by SCMP. Once again, there is a lot of small print, but basically SCMP says that pay for the first team squad cannot exceed 60% of turnover in any year. Most of the small print is used to define the terms ‘Turnover’ and ‘First Team Squad’. Given that turnover in League 1 is £6m lower than turnover in the Championship because of the reduction in TV money. That gives clubs a problem. They have to reduce the level first team pay, back down to 60% of the reduced turnover figure. Without planning, this would result in a fire sale of players by relegated teams, and in fairness, that is often the outcome. However, the last time that we were relegated, we only sold Tom Bradshaw (who was immediately replaced by Cauley Woodrow) and Brad Potts. Not exactly a fire sale. So what happened?


Our 2017/18 Financial Statements provide us with the following figures for Turnover and Pay when the club last played in the Championship. We were relegated at the end of that season after a stay of just 2 seasons:


Turnover £14m

Pay £10.6m



However, the figure for pay is for all pay, and that covers more than 200 employees, whilst the first team squad that year averaged just 21 players.



In the next section, I am going to use numbers to illustrate the points that I am making. I do not know what the actual figure for 1st team squad player wages was the last time we were relegated from the Championship, but in the first example, I am going to assume it was £7.7m, that is an average of around £360k per year per player (or £7,000 per week). In the second example, I am going to assume that squad comprised 25 players, and those 4 additional players are older players who the club pays an average of £500k per year, thus increasing the total pay budget to £9.7m. I am going to assume that the younger players all accepted that if the club was relegated, their pay would reduce by 40%. However, the older players would not sign contracts that included a relegation clause, even though in all cases the relegation clause is offset with the right for a player to seek a transfer if the relegation clause has been invoked. The older players argued that it would be hard to find a club that would pay them the same terms if they had been part of a relegation squad (very likely in the case of Barnsley FC), and rather than lose out on their signatures, the club had agreed to forego the relegation clause.

 

The Financial Shock of Relegation (2)


Example 1

Why I have chosen the figure of £7.7m for the player pay budget will become obvious as we get into the example. We know that when the team is relegated, the pay of the players is reduced and I am going to guess that the amount of the reduction is 40% (£3.1m). That means that the new figure for pay will be £4.6m net. That figure must be no more than 60% of the lower turnover figure (£8m). 60% of £8m is £4.8m.


Now these figures are no more than illustrations that indicate the principals involved. Nevertheless, it is interesting how close to the target my projection for the revised player pay budget is. It was that outcome that first alerted me as to how the club might be managing the financial shock of moving between leagues, and I wondered whether it is a policy that the club is actually engaged in pursuing.


The answer to the problem of what to do about a huge financial shock is to ensure that there isn’t one, to keep the same relationship between player pay and turnover, even after the club is promoted to the Championship. 60% of £14m turnover is £8.4m and the above player pay figure of £7.7m is well within that number.


We know that Turnover is restored to the previous levels when we return to the Championship (an addition of £6m), but £3.1m of that sum will go towards restoring players’ pay to previous levels, so the club has only £2.9m of additional turnover (net), and it is likely that the club lost more than the projected £1m that it loses in the Championship during its season in League 1, in spite of the sale of Bradshaw and Potts.


The above figure for turnover (£8m) does not include any player transfers, but before readers get too excited, for SCMP purposes, only 50% of player sale proceeds actually count towards turnover. (One of the items of small print says that only the cash actually received from transfers can be added to turnover, and usually only 50% of a fee is received as a down payment, with the other 50% paid over the following 2 seasons). All that means that cash is probably tight on our return to the Championship, in spite of the £6m increase in turnover (£2.9m net).


Example 2

In the 2nd example, which is much more of a fiction, the player pay budget in the Championship (including 4 older players) is £9.7m. If we are relegated, in spite of the higher budget (and that is quite likely given how far we are behind the general level of spending in the Championship), then the player pay budget in League 1 becomes £6.6m, as compared to the SCMP allowance which is still £4.8m (£8m turnover x 60%). That leaves the club needing to reduce player pay budgets by £1.8m. Clearly, it needs to sell players or it faces a fine and a transfer ban. If the club transfers the 4 older players, it meets the SCMP rules, but will they go? If we ask them to go and do not ask for a fee, then they can look around the marketplace and can assess if they can maintain their current pay levels after going through a relegation with us last season. They all have 2 years left on their contracts with us, so they are not under any pressure. If they cannot match their pay at another club, why would they go? We could offer them a lump sum to go, but that would appear in the player pay budget. We know that if we sell a player, we are only allowed to use the amount of cash actually received for SCMP purposes (plus amounts received in respect of transfer fees agreed in the previous 2 seasons). In order to make up the £1.8m deficit in the pay budget, we have to receive cash from transfer fees amounting to £3m. That is the equivalent of current season transfers of £6m, assuming only 50% of the fees are paid up front. That sum is obviously lower if fees are received this season in respect of player sales in the 2 previous seasons. But does it make any sense at all to sell up and coming young players, whilst retaining the services of older players, because if we are not promoted this season, we have the same sort of problem next season, the final year of the older players’ 3 year contracts. There is another option, but I guess the owners would be even less willing to make donations of £3m to cover the shortfall, than they are to loan the club money. Their philosophy is that the club must live within its means, which means that they continually have to look for the downside in every situation.


Whilst the fans would in most cases risk everything for a higher league position and more wins, those in control of the purse strings know that the odds are just too great. (How about it @Orsenkhat. Would you risk your house at those odds?)


Now the first reaction to my figures is bound to be that they are a fiction. That is a charge that I immediately accept. I have absolutely no objection to others rubbishing my numbers, and producing their own figures and publishing them in this thread. The one thing that I insist on though, is that the new figures must comply with the SCMP rule that only allows player pay to be a maximum of 60% of the club’s League 1 Turnover (adjusted for transfers and donations).

 

The Financial Shock of Relegation (3)


But why were so many players sold following our return to the Championship?


Well, as I said above, the contracts between the club and the players cannot, and will not be one sided. A term that favours the club (reduction in pay following relegation) must be matched by a term that favours the player. Otherwise, why would a player sign a one sided contract in the first place? After all, he could be signing up for 3 years out of 4, where his pay is just 60% of the figure that he expected. The figure quoted in his contract. The fact that the club has the discretion to reduce player pay in the event of a relegation, probably means that there has to be another clause in the contract that allows the player to move on if the relegation clause has been invoked. If most players chose not to invoke that clause until they had made use of the intervening period to restore their reputation following the knock that relegation imposed, it would not necessarily mean that the clause did not exist. It might just mean that the player was awaiting more favourable circumstances before invoking the clause. Of course, that wait also favours the club because it allows the club to make use of the services of the players to achieve promotion, and of course, it increases the player’s transfer fee once promotion has happened.


This is another area where readers could label me a fantasist. After all, I have no proof of such a clause. My argument relies heavily upon the belief that no-one would willingly sign up to a deal that could commit them to a remaining contract period of 3 years at a rate of pay which is 40% less than they expected.


But why have our new signings been so young?


If I am right, and the club is keeping the relationship between player pay and turnover at 60% even in the Championship, and it has also decided that the club needs to increase the size of the first team squad, then the pay of the new players plus the remains of the squad from the previous season must not exceed £8m. How is it possible to increase the size of the squad, and yet keep to a budget that is so restrictive? The only way that I can see that such a thing is possible, assuming you do not make use of the loan market, is to bring in younger players. Young players are willing to put off short term pay aspirations for experience and exposure at a higher level of football, a level where they will attract attention from richer clubs provided they can perform at a decent level. It is an accepted and unwritten part of that deal that their new club will sell them on if they get a good offer. It is in neither the player’s interest nor the club’s interest to upset the apple cart. If the club does not do right by the players, they will attract a reputation for being untrustworthy, and such a reputation would stop young and talented players signing for it as part of their long term career path to the big time. The whole thing is a delicate balance between the interests of the club and the interests of the player. A cat’s cradle that can be brought down if any party tries to break its promises, both real and implied. I know that is not what fans want to hear. For them, the club is at least as important as any other club. However, the sad reality is that those in the game do not perceive our club the way that the fans do. The owners are caught in the middle, under pressure from the two extremes. They have to construct a niche way of trading that allows for all opinions. A way that allows the club to continue in business. A way that utilises, rather than fights against the natural greed that pervades the football industry.


So why doesn’t the club try to break out of its yo-yo existence. Why doesn’t it go for broke?


The strict SCMP rules absolutely forbid improving our playing staff in advance of promotion to the Championship, unless those improvements can be achieved within the rules. That means that going for broke effectively means that we can only invest heavily following our return to the Championship. So what is stopping us?


The fact is that investing £30m on established Championship players, a figure that would not be considered extraordinary in that league, would also increase our annual first team squad pay bill by £15m. That means that we will have lost £25m in that first year back, and at least £25m in the year after. We would have broken FFP rules in just 2 years, rather than the three it was designed for. What would that money buy? Would it buy a guarantee? Unfortunately not, and neither will it buy an injury free season either. It is a huge risk, with the promise of a £20m fine and transfer ban to follow. Furthermore, there is little prospect of selling those players for a profit in the event of our relegation, because the players are older and rather than each new year increasing their value, instead each new year decreases their value.


About the only chance of growing the club organically comes from a sizeable increase in admission prices or hitting the jackpot with one of our young players and selling him to the Premier League for a huge sum (with add-ons). Of course, the Championship could collapse eventually, and perhaps that is the sort of shock that is needed in order to bring about a realisation amongst owners that things have to change. Many of the clubs there are insolvent, and are kept going only through the generosity and financial support of their owners.


Readers will have noticed that nowhere have I suggested that our owners dip into their own pockets in order to loan money to the club and follow the example set by other Championship clubs. There might be a time when I do suggest this, but that time is not now. Trying to compete in the Championship whilst it resembles the Wild West is an invitation to throw your money away. At the minute, putting money into Championship football is not an investment, it is a senseless gamble. I am happy that we continue to yoyo between the leagues until the time is right for proper investment. And as I say, that times is not now. OK, the club appears to be being blown about by forces that are totally outside its control. A victim of circumstances rather than a master of them. That is unfortunate, but in order to change that situation, the proposer has to have a better plan, and frankly, I have not seen one.


Once again, I have cut myself off from the BBS in order to write this piece. It has not been tested or challenged through the process of debate. I understand that talking about finance is not what most football fans want to do, but equally concentrating solely on the game means that you do not have any explanation when things happen that you do not like. Whether we like it or not, cash or rather the absence of it are major influences on decision making.


I would welcome suggestions as to where I have gone wrong. I would welcome any input suggesting alternative strategies. Thank-you for reading.

 

It does beg the question why once more? Why the owners have chosen to invest in a football club with a limited fan base, no glamorous history to look back on and no international footprint.

The more you think about it the more it becomes a player trading model.

All fan income is less than £4m whereas hitting the jackpot on player sales could dwarf that. Keep wages on a division one footing, trade players and through sheer club loyalty the fans will still turn up.

 

So, in essence we are faced with the prospect of relegation every other season. Assuming we manage the upward yo-yo of course. No wonder I’m feeling glum.

 

Open top bus company will be happy though!

 

I am a lot less cynical than that. I believe that the owners have a long term plan, but that the two key word in that statement are "long term". The EFL rules are not of their making, but they have to live within those rules. There is no alternative. I am just trying to illustrate how hard that is. How hard it is to survive in football these day if you are not prepared to put the business at risk through building huge debts.

The BBS seems to think that all you have to do is ignore the Balance Sheet and everything will be alright. The Balance Sheet reports what has happened. It is not a tool to use or ignore. One of the balances that it reports on is the bank balance, and if that goes into overdraft, the business has a problem that cannot be ignored. But that is what this argument suggests. You just spend what you need to spend to get us safe, and everything is fine thereafter.

No it is not, and as much as anything, this series of articles is about giving readers the tools that they need to reach that conclusion themselves.

 

As I have said in another reply, I am not so cynical as to think that there is no hope. This series of articles is about giving people the tools that they need to put themselves in the chair of the CEO and the owners. These are pressures that they face, and they have to find a way through them. They have a plan. It is a long term plan, and long term does not mean 18 months. Part 5 of this series will look at that long term plan, but before I can do that I must set a context. The context is, it will not be easy. However, we have a lot more chance of getting there with a plan and a strategy. Spending cash you do not have is not a plan. It is the road to extinction.

 

No plans should be inflexible though.

 

A good insightful post @Red Rain as ever.

The only thing I would say is few of us would have expected us to pay massive sums for experienced players. Maybe signing one or two less youngsters for fees approaching £1 million & signing a couple of experienced players, the likes of Butterfield on a one year deal, with an option maybe of an extra season, if we stay up. That could be linked to a possibility of joining the coaching set up after their careers end, if they are looking at such a route. Given that should we go down, or even are cut adrift in January offers for Woodrow & Mowatt & maybe others should help to reduce the player budget, as we won't keep them back in L1 in my opinion. Being stuck rigidly to any "plan" in my book will never see us move forward. Different times, but we signed ageing players like Wilkinson & Hendrie for peanuts in the transfer market, although they were on significant wages, maybe the equivalent of £500k per annum in today's market. The difference they made, to a largely youthful squad totally transformed our season. I'd wager also the loan of Kevin Long transformed the earlier promotion team.

 

I do not really want to talk about the plan too much just yet, but just what level of flexibility are you expecting. You now have a lot of information at your finger tips. If you go back to Talking Finance (2) you know roughly where we are in the pecking order for pay. If you look at Taking Finance (3) you know what the disadvantages are of paying more, and still being relegated. You have just about enough information to formulate your own plan and publishing is on here with a detailed justification and financial analysis. So do not be vague. Let us know where there is flexibility.

My reply seems a little harsh, doesn't it. It is harsh, but anyone can pretend that they understand the problems whilst pontificating on social media. Our owners have to solve just the problems that I describe in real life.

 

I do not want to go too far back into history because FFP and SCMP are new phenomena, just as are the huge loans that some owners have made to clubs. We are in a new era, a new era with new rules. I urge you to forget the past and look at things as I have described them, because unless we change ownership again, and this time we drop on owners who see a different way forward, these are the rules that we are playing by.

 

It’s perfectly possible to sign players with experience. Tens of similar financial stature such as Charlton and Luton do it. To say otherwise is disingenuous at best. We choose not to. It’s not about reliving the past it happens with other teams now. Martin Cranie at Luton for example. Our decisions are not made based on sporting concerns they are purely financial.


I would be happy if we made 80% of our decisions to make money for the owners and 20% to achieve on field success. In reality a 100% !of our decisions are based on financial return.

Anyone who has ever worked within any sort of business recognises that myopic following of any one course of action while excluding even the consideration of all others is doomed to create stasis and failure.

 

The financial reality of Division one would suggest that the club could have a wage bill of £7m. If you assume a very different pay structure where you combine experience with youth this would allow for six players on £10k a week, 10 on £5k and another 10 on £2k a week. 24 players and an annual wage bill of £6.5m. A combination of experience and youth but well within SCMP and leaving a buffer for additions to the squad.

I'm not saying that this is corect but the assumption that the addition of experience cannot be accommodated alongside a solvent club is not necessarily correct.

I spend most of my working life with private equity and with very few exceptions, they do not have long term aspirations for capital investment. (Apart from those which go wrong!) Their stay at Nice was hardly long term...

 

Whilst I agree with much of your viewpoint on this, we did just get promoted automatically for the first time in 20 something years with record points, unbeaten at home... and not selling off all our good players was a big part of that. And, as Red Rain has made clear, we are clearly operating similarly in financial terms as we were during the Cryne years. We aren’t taking any kind of risks or gambles anymore.

I am one of the most vocal when it comes to saying we should have added a handful of experienced players in key positions. So I’m with you there. But we don’t know for certain that we’d be any better off. In fairness we’ve competed for the most part very well in the majority of games but we aren’t ruthless at all in either box.

What if we stay up this season? Were we wrong and the club right?

 

Charlton operate a tighter budget than us cos he want out!

What he has realised though is a champsionship club is worth more than a L1 club.

 

He also did what he had to to get Bowyer to stay on.

 

In fairness our model sees League position as irrelevant. In some ways a player will be worth more scoring 25-30 goals in L1 than 5-10 in the Championship.

 

And theyll progress and be a strong club, more attractive proposition etc.

They keep mixing old heads youth players and signings with potential.

Selling piecemeal to balance the books and layering.

Whereas weve gone and signed the local youth club.

 

As it stands none of our current squad will get 25 goals in L1 next season.