It is once again that time of the year, when football clubs begin to
release their annual reports. And once again, we get to read how several clubs
are making heavy losses. Even some of the most succesful clubs often fail to
show financial profit for their efforts, no matter how many titles they have
won during the season of how well they have performed at the Champions League. While
this often seems puzzling, the reasons for the situation are no secret.
Succesful clubs have to pay enormous wages to the playing squad. They also have
to pay high transfer fees in order to build their squad to a level that will be
able to compete for trophies. Often the money used to build and sustain a team
is almost as high as the revenue the team can generate. In some cases, it´s
even higher. But what exactly are the mechanics behind all this, that cause the
annual reports often show such ugly figures?
Before going any further with this topic, it must be stated
that many of the ideas and explanations presented here are generalisations, and
many of them are presented in a simplified manner. While things are rarely
black and white, some simplification is needed in order to find the key points
and relevant issues.
When looking at normal companies that operate in any kind of
businesses, they can usually be categorized as labor intensive (LI) of capital
intensive (CI). A labor intensive company, as it´s name suggests, is one that
uses mainly labor to generate whatever output it is they are producing. This
naturally means that most of the companys costs are labor-related, such as
wages. Capital intensive companies, on the other hand, are companies that
require heavy assets, such as machinery, to produce their output. In this case,
a lot of the costs are related to that machinery. In real world, this kind of
distinction is naturally too rigid. Most of the companies are not strictly one
of the other, but have features of both. People rarely work without any kind of
assets at their disposal. Machinery rarely runs itself, without someone to
operate it. But for the sake of argument, let´s go with the simple distinction.
When looking at a companies profit and loss account, there
is usually a distinct difference between capital –and labor intensive
companies. The profitability is often
measured using the EBITDA (Earnings before interest, taxation, depreciation and
amortisation). Below is presented a profit & loss –account of a random
labor intensive company. Once again, it is a simplified one.
Let´s say this fictional company produces some kind of
consulting services. Their turnover is £ 56 million. Most of the costs of this
company are the wages and salaries of it´s employees, these costs represent 77
% of the turnover. Brainwork is what these guys sell, and the costs of it are
in the form of wages (and most likely bonuses). There are some material costs
etc, and other operating costs worth £ 5 million pounds. Their EBITDA is £ 5
million, or 9 % of turnover. Whether this is a good level or not, always
depends on many things, like general economic climate, normal industry level,
competitors, etc. The points is, for labor intensive companies the EBITDA
–level is usually lower than for capital intensive companies, because most of
the costs are wages, i.e. they are before the EBITDA in the profit & loss
account. Having a lower EBITDA is nothing to be ashamed about. It can be low,
because there are usually very little costs below the EBITDA-level. As the
figure above suggests, this company has depreciations worth £ 0,2 million. They
have some assets in their balance sheet, and the value of those assets
depreciates every year. But the balance sheet is quite light, there are not
that much of these assets. There are also some interest payments (£0,1
million), indicating that the company has some liabilites (bank loans, for example) that they have to
pay interest for. But again, the amount is very small. Since this compay needs
very little assets to run it´s operations, it also needs very little external
financing as well. As a result of all this, the company made a £ 2,2 million profit
for the period. Having a 9 % EBITDA was easily enough to make the year a
profitable one.
Looking at a capital intensive company, the profit &
loss account is a very different one.
Let´s say this is an industrial company, producing some sort
of machinery. It´s not a very big company, turnover is only £ 61 million.
Compared to our previous company, we can instantly see that wage bill is
significantly smaller, 36 % of turnover. Material costs are 31 % of turnover.
The EBITDA is much higher in this case, it is 16 %. It is higher than in our
consultancy firms case, but as we will
see, it needs to be. Because while the consultancy company had vey little costs
after the EBITDA, this company does. The depreciations are £ 2,2 million, because the machinery this
kind of company uses loses it´s value over time. In order to keep the business
running, the company needs to invest in new assets, or update and repair the
old ones. These kind of investments are rarely done using only shareholder´s
equity. Normally at least some amount of bank debt is used, and consequently
interest payments etc. reduce the profit. In this case, the company has £ 1,3
million in interest payments, which is 13 % of EBITDA. So while these two companies
both made profit, one did it with lower EBITDA and low depreciations and
interest payments, the other had higher EBITDA, but also higher depreciations
and interest payments.
If we look at a top football club, is it capital intensive
or labor intensive, then? It is in fact both, and this is why it´s so difficult
to run these clubs profitably. In order to compete at the highest possible
level, clubs naturally have to invest in players. When a player is bought, the
transfer fee is not marked in the profit & loss account as one single
payment, but it is marked in the balance sheet as an intangible asset. Then,
it´s value is amortised over the duration of the contract. For example, when
Fernando Torres moved from Liverpool to Chelsea for a fee reportedly around £
51 million with contract duration of 5,5 years, the annual amortisation of his
transfer fee would be around £ 9 million. Quite a lot. Whether Chelsea ever got
enough in return for all that money is debatable. The point is, a club that buys
a lot of players with high transfer fees, needs to deal with high annual
amortisations. Since player contracts are treated as assets, it could be argued
that football is a capital intensive business.
But the thing with players is that while they are assets
that a lot of the time cause large amortisations, they are not exactly machines
that you can just plug in and switch on. Quite the opposite. These are the kind
of assets that need to be paid heavily in wages, as well. Many football clubs´wage
bills are extremely high, on many occasions around 80-90 % of the club´s
turnover, sometimes even close to 100 %, or over it. Going back to EBITDA, many
clubs have a very low profitability because of the huge wage bill. Add high
amortisations on top of that and it´s no wonder that many clubs make heavy
losses. Also, if there is no wealthy owner to back it up by providing equity,
the club usually needs to handle some interest payments as well. More often
than not, yearly losses can be ugly.
Below is Liverpool FC´s profit & loss account for the
season ending 05/2013.
Liverpool had a turnover of £ 206 million. Administrative
expenses were around 80 % of turnover, most of this being wages. As a result,
the profitability was positive (EBITDA was 7 % of turnover), which wouldn´t
have been that bad for a company without high amortisations. As it turns out it
wasn´t enough for Liverpool, not by a long shot. Amortisations and impairments
of player registrations pushed the operating profit all the way down to £ -32,6
million. Loss on disposal of player registrations (£ 12,7 million) and net interest (£ 4,4
million) made it even worse for Liverpool, and profit for the period was £
-49,8 million.
This is not to say football clubs are unable to make profit.
There are clubs that have taken a cautious approach to their expenses and are
making some profits as a result. Even Chelsea, who are far from cautious, and who have been making substantial
losses over the years had a profitable last season, boosted by players sales.
So there are profitable clubs as well. But if a club wants to be at the top,
playing for trophies and titles, heavy investments and wages are ususally
needed, and that can lead to the kind of vicious cycle described above. The
situation can always be improved by selling intangible assets as well. But if
you sell assets strictly to improve the numbers, it more often than not comes
back to haunt you results-wise. The problem exists also at the lower levels of
the game. In the British Championship, many clubs have wage bills that are
close to 100 % of their turnover (or over, like Bolton whose wages/turnover-
ratio was 107 % in 2013). This is because they desperately want to achieve
promotion to the Prmeier League, where the TV-money, sponsorship –income etc
are enormous compared to the Championship. Having a huge wage bill might be
needed in order to achieve that goal. But it is a gamble that can prove to be
very costly, if that elusive promotion is not to be achieved. Even without any amortisations or
interest payments, any business that has costs close to 100 % of their
turnover, is not a sustainable one in the long run.
Financial Fair Play regulations are designed to keep clubs
from spending beyond their resources. Time will tell how that will shape the
whole industry in the long run, but so far many clubs are still stuck in this
merry-go-round. And for clubs that have built their situation over several
years, it´s not easy getting out of it quite so fast. Not, at least, if they
want to keep improving their game as well, instead of just the numbers.
