Here is a collection of articles by Colin Savage, first published in MCIVTA at the start of the 2006/07 season, describing the financial structure of the Club and its workings.
There has been a lot of interest in and debate about the club's finances over the last few years and about the only thing that is clear about these is that they are not clear to most people and many would like to understand the accounts and our overall financial situation better. Questions such as:
I'm not a financial wizard and I don't have any insider secrets or "smoking gun" that will blow the lid off City's finances but I do know a little bit about these things. I cannot advise you whether to buy the shares or not as I'm not authorised to give investment advice so you will have to make your own minds up. However, I would like to try to de-mystify some of the figures and issues around the finances. I am planning about 6 articles and the first one is around the issue of the ownership and management of the club. The latest accounts will be out next month and I'd like to do what I can to help people understand these.
Part 1 : The Club's Shares, Ownership and Management
This is the first of a series of articles in the lead up to the publication of the annual report and general meeting. In it, I have attempted to clarify the share-holding position, the structure of the club and who does what on the board.
Manchester City is a "publicly quoted" company. This doesn't mean that we're always in the press but that our shares are traded on a recognised stock exchange and can be easily bought and sold. The market involved is called Plus (formerly Ofex) and specialises in smaller to medium size companies. Their website can be found at http://www.plusmarketsgroup.com/. The Manchester City page can be found at: http://www.plusmarketsgroup.com/details.shtml?ISIN=GB0005599336. Other sporting members of Plus are Arsenal, Glasgow Rangers and Northampton Saints Rugby Club.
Anyone can buy the shares, through a stockbroker, and being a shareholder entitles you to attend the Annual General Meeting, vote on various matters and question the directors. The AGM is a statutory requirement and is usually held in December, following the publication of the annual report and accounts in October. In the past, with the various boardroom upheavals, these have been lively affairs but have been quieter recently. However, the handling of last year's meeting led to some dissatisfaction and, with increased focus on the finances following the sale of SWP, things could start warming up again!
The more shares anyone has then the more they have the capacity to influence events. On the basis of "one share, one vote" then anyone who owns over 50% of the shares controls the company. In the case of our friends in Salford, the Glazer family (bless them) own virtually all the shares and have made their company "private". This means they do not have to issue accounts publicly or hold an AGM. Therefore their supporters don't have a clue. Sorry, that should read "don't have a clue about the financial affairs of the company."
We know who the major Manchester City shareholders are as there is a requirement for public companies to declare any shareholding of 3% and over and these are detailed in the annual report. There are just over 54 million City shares in circulation and the current share price is quoted as 28p. This is what is known as a "mid-price" as the price for buying a share is higher than the price for selling. So currently you can buy shares at 29p each but would only get 27p each if you sold them immediately. The difference is the stockbrokers' profit margin. There is no minimum investment but many brokers will levy a flat dealing charge up to a certain level. So the fewer you buy, the greater the average cost per share.
The share price is a reflection of the financial worth of a company and its perceived prospects. Multiplying the number of shares by the mid-price gives what is known as the market value of the company. Therefore, in theory, MCFC is valued at just over £15 million. Compare that to Aston Villa, which has just been sold for about £64 million (but there are reasons for the higher valuation). MCFC has over 5,000 shareholders but there are four who matter.
The largest group of shares are held between John Wardle, the Chairman, and his former business partner in JD Sports, David Makin. Some are held in John Wardle's own name and some are held jointly between him and David Makin but the overall holding totals 29.95%. The significance of this level of holding is that anyone who owns 30% of a company's shares is obliged to make an offer to buy the shares of the other shareholders. Therefore unless they plan a full takeover of MCFC then Messrs Wardle and Makin will keep their maximum shareholding at this level. Although they don't own over 50% they clearly have a large say in events at Manchester City.
The next largest shareholder is the Boler family. The late Stephen Boler built up a substantial stake in MCFC some years ago and this currently represents 18.75% of the shares. Sadly, he died in 1998 but his family's interest was represented on the board by Ashley Lewis for a number of years. He stood down last year but Stephen Boler's son, Mark, joined the board earlier this year. Stephen Boler was a friend of Peter Swales and was believed to be very upset about the way Swales was treated at the time of the Francis Lee takeover.
The third largest shareholder is BSkyB, with 9.88%. Sky has held shares in a number of clubs and was blocked from a takeover of Manchester United a few years ago. It is unclear what their motive is in owning shares in football clubs although it may have something to do with being able to influence negotiations on TV rights. They bought their stake when we were running away with the First Division in 1999 and paid £7.5 million for it. It is currently worth around £1.5 million so they are sitting on a big loss.
The last of the big four is Francis Lee, who of course endured a turbulent period as chairman after an acrimonious battle with Peter Swales. He still owns around 7% of the shares and, like the others, is probably sitting on a big loss currently. Lee is not on the board and it is unclear whether he is just hanging on to his shares until the price increases further or whether he has other plans. However, if the share price carries on towards 50p it will be interesting to see what all the four groups do.
Between them, these four own around two-thirds of the total shares. This leaves one third of the shares in the hands of around 5,000, smaller shareholders. There are many people, like me, that have a few hundred shares and about 300 of us turned up to the last AGM.
Many companies pay a dividend on their shares. This is expressed in pence per share and is a share of the profits given to the investors (i.e. the shareholders). It is akin to interest on your savings except that it might be nothing or could be a very good percentage in any given year. This, as well as the fact that shares can increase in value, is the reason that stocks and shares have become a popular and standard form of investment. MCFC shares have not paid a dividend for many years because the financial performance of the company has meant there is insufficient cash to fund this. Even a dividend of a penny per share would cost us over £500,000 and just imagine what SP could do with that!
However, it is interesting to note that the share price has been rising steadily and has doubled over the last 12 months. There is no obvious reason for this but it may reflect a feeling that the finances are improving, there is a potential investor waiting in the wings or simply a view in the markets that, in view of the takeovers of Manchester United and Aston Villa among others, football club shares could be a worthwhile investment again. They still have some way to go to reach their highest price over the last five years, which is just over 50p. There are a number of clubs where groups of supporters known as Supporters' Trusts, own some or all of the shares in their club and there was an article on this in MCIVTA 1251. If we (the supporters) could somehow combine these small holdings into a more significant bloc (say of 10% or more) then we could wield far more clout than we do now.
The club is run by a Board of Directors, who have a number of legal responsibilities (such as preparing accounts). The board at MCFC, in common with many other companies, has a Chairman and a Chief Executive, plus a number of other directors. In our case there are three more directors and this is on the low side as other clubs can have seven or eight.
Directors can either be "Executive" or "Non-executive". The former are full-time employees of the company and are paid a salary. Typically, there would be a chief executive and a finance director, and maybe some others (Marketing, Sales, Operations, etc.). Non-executives are not full-time employees, although they are usually paid a fee and expenses. Their rôle is to guide the executive directors and also act as a check and balance, to ensure that the executives act in the best interests of the shareholders. They may well be executive directors of other companies. The question is often asked "What do these people do for Manchester City?"
The chairman has overall responsibility for setting the direction of the club and, as I have already detailed, our chairman is also the major shareholder. The chief executive has overall responsibility for running the business side of things and most, if not all of you, will already know that our chief executive is Alistair Mackintosh. He is a chartered accountant who was originally our finance director. He is not a major shareholder (although he has a few thousand shares) but he is the only executive director. It is only relatively recently that full-time, paid directors were allowed at football clubs. Martin Edwards and Doug Ellis were among the first to take advantage of this change.
The other directors are Brian Bodek, Dennis Tueart and Mark Boler. All of these, as well as John Wardle, are non-executive. Bodek is an executive director of a couple of other companies and is a qualified solicitor. Tueart needs no introduction as he was one of our finest players of the last 30 years but he has also built up a very successful sports promotion business. At the last AGM, it was stated that Brian Bodek provides valuable (and free) legal advice to the club and Tueart has responsibility for playing affairs. Neither Tueart nor Bodek are significant shareholders although, like Mackintosh, they have a few thousand shares. Mark Boler represents the interests of the Boler family. They have a near 20% stake in the company and it is usual for anyone with this level of shareholding to have a seat on the board if they want one. In that way they can keep a close eye on their investment. It is generally believed that Brian Bodek performs this rôle for BSkyB.
Therefore, not all of the directors are major shareholders. Bernard Halford, as Company Secretary, will also attend Board meetings.
At the beginning I said that MCFC was a publicly quoted company. In fact MCFC consists of a number of companies. The most important of these (and the one in which the shares are publicly traded) is Manchester City PLC (standing for Public Limited Company). You might think the word "limited" refers to our footballing ability but in fact it means that the shareholders are protected against having to pay any outstanding debts of the company if it fails. So their liability, if this were to happen, is limited to the amount they have paid for their shares. Manchester City PLC actually owns three other companies that make up the group.
One is Manchester City Football Club, which is self-explanatory. There are various reasons why the football club is owned by another company and one is that there were various restrictions placed on football clubs by the FA that can be got round by having a so-called holding company (not to be confused with a holding midfield player). This is a company that is set up for the purpose of owning a majority or all the shares in another associated company. Tottenham Hotspur was the first to go down this path in 1983.
The two other subsidiary companies are Manchester City Investments Limited and Manchester City Property Limited. The former "owns" the long term, £44 million debt issued a few years ago and the other, I believe, "owns" the lease on the stadium (more of these in a subsequent article). The establishment of these companies may well have been a requirement for these transactions.
I hope this has given you some idea of the structure and ownership of MCFC. If anyone has anything to add to this or I have made any howlers then please feel free to tell me or preferably publish your views in MCIVTA. I would also be grateful for any feedback as to whether the level is right or not. In the next instalment I plan to look at the contents of the Annual Report and talk about the Annual General Meeting.
Part 2 : The Annual Report and the AGM
Firstly, thanks to everyone who gave me feedback. It was very positive and has encouraged me to carry on in the same vein. So here's the next instalment, covering what goes into the Annual Report and what happens at the Annual General Meeting.
Like any business, Manchester City plc prepares annual accounts. With them being a public company, these accounts are sent to shareholders and are made generally available to anyone else who is interested. The link for these is as follows: http://www.plusmarketsgroup.com/reports.shtml?ISIN=GB0005599336. These follow a fairly standard pattern as required by company law and market regulation. So what's in there and what does it all mean? I'm going to concentrate on the general headings here but I will go into the 2005 figures in more detail in subsequent articles.
Taking the 2005 Report as my template, the first page (2) details the directors and the various advisers - our main bankers, auditors, solicitors, etc. Nothing terribly remarkable here - all our advisers are well known and very reputable companies. Brian Bodek used to be a partner at Kuit, Steinart, Levy, one of the solicitors we use. He left in 1998 but is still listed as a consultant.
The next few pages (3-7) contain the Chairman's Statement. This is a report on the past year written by John Wardle and sums up our financial performance, on-field performance and other items of interest. In most company reports, these tend to be pretty formulaic, with little illuminating comment. It should be noted at this point that these accounts cover the year to 31st May 2005, which is our financial year-end. However, any significant changes between then and the finalisation of the report have to be reported. One such change was the sale of Shaun Wright-Phillips to Chelsea, for a guaranteed £21 million, and Wardle talks of his surprise at SWP's sudden change of heart.
One of the statements that is revealing concerns the uses of the proceeds from that. These include investing in the Academy, reducing outstanding borrowing and paying off all outstanding instalments on players purchased in previous seasons. Oh, and whatever's left might be spent on new players. So, in other words, goodbye to any lingering hopes we might have had that the sale represented a superb opportunity to build a strong squad that could capitalise on our eighth place finish. He makes it clear that he considers it more important to strengthen the balance sheet than the team.
He also talks about reducing the debt and backs it up with some figures to show how our debt is reducing. Net external debt, he tells us, is down from £50 million in 2004 to £38.5 million and total debt down from the oft-quoted £62.2 million in 2004 to £57.7 million. So that's good isn't it? Well in the next article I'll discuss our debts but in the meantime make a note of what you think our total debt really was in 2005. The answer might surprise you.
The next few pages (8-15) are the Directors Report and associated statements. There is some detail about each director although it doesn't make it clear whether each director is executive or non-executive (as it should). I talked about the difference between the two in my last article and identified which directors fell into each camp.
The Report is in a pre-defined format but there are some interesting bits worth noting. Firstly, each director has to formally retire and offer themselves for re-election every three years and in 2005 it was Brian Bodek's turn. This is usually fairly straightforward but some of you may remember that Magnier and McManus were able to put pressure on the Manchester United board by voting against the re-election of a couple of retiring directors. We can see that, just before the year-end, Ashley Lewis resigned as a director.
The next section on Substantial Interests is really important. It lists any shareholdings known to consist of 3% or more of the total shares. This means we know who the major shareholders are and whether there have been any changes from the previous year. Generally speaking, any significant changes would have to be reported at the time they occurred, rather than waiting until the accounts are published. Therefore we already know that Mark Boler became a member of the Board earlier this year.
The first section on Page 10 (Corporate Governance) is particularly interesting in this report. It details how the company ensures that it is managed correctly at the highest level. They should comply with something called the Combined Code, which sets out best practice in this area, and they should be able to demonstrate how this was achieved during the year in question. So they talk about regular board meetings and scrutiny of the financial results to ensure any problems are identified early.
The Combined Code talks about the establishment of committees to ensure that proper financial controls and suitable accounting policies are in place (the Audit Committee) and one that covers all aspects of directors' and senior management remuneration (the Remuneration Committee). These should both be made up of at least two non-executive directors, according to the Code. The Audit Committee should ultimately ensure that a Chief Executive and/or Finance Director are looking after the financial side of things properly but look who's one of the two members of the Audit Committee: it's none other than Alistair Mackintosh, who is our Chief Executive (and therefore an executive director rather than the non-executive suggested by the Combined Code. So effectively he is checking his own work, particularly as he was also our Finance Director previously (and still is to all intents and purposes). Up to 2005, Ashley Lewis had been on the Audit Committee but he was no longer a Director at this point.
I wrote to Alistair Mackintosh to query this after the last AGM and he replied that our external auditors were happy with this. However, he did not make it clear how they had indicated this. It could be that he meant that they had not said they were unhappy, which is not quite the same as specifically saying they accept the situation. It will be interesting to see if the position has changed in the next report.
The Remuneration Committee report takes up the next few pages (12-14) and this is another safeguard designed to ensure that the executives and senior managers don't simply award themselves inflated salary and benefit packages. There is a section on share options, which are supposedly a device to reward executives for their performance by giving them a stake in the company, potentially at an advantageous price. A share option gives an executive the chance to buy shares within a defined time period at a fixed price. Mackintosh therefore has the ability to buy up to 200,000 shares at any point up to March 2010 at 45p each, regardless of the market price at the time. If the market price were significantly in excess of 45p then this would be a very valuable benefit but it is clearly not in his interest to pay 45p for shares that anyone else can currently buy for 29p. The incentive, from his point of view, is to push the share price up via attracting external investment at a suitable price or superb financial performance.
The final part of this section details the shareholding of each director and their remuneration for the year. Mackintosh received a salary of over £170,000, a bonus of £50,000 plus a £10,603 contribution to his pension fund. Page 15 is a statement of the directors' legal responsibilities.
Page 16 contains the Auditor's Report. The auditors are an external, properly qualified accountancy company (in our case KPMG). They are supposed to ensure that the accounts presented fairly represent the true state of affairs of the company. They will have examined the accounting records and checked that the accounting policies we use to state the figures are appropriate, prudent and take into account all foreseeable circumstances. They will ensure that transactions have been properly recorded and reflected in the accounts. So, for example, they would want to be sure that our attendance figures are recorded accurately and that all the associated revenue from those tickets had found its way into the accounts.
As a former auditor myself, I had to do things like count millions of bricks in a brick-maker's yard (as the correct stock figure is critical) and stay in a casino all night until seven in the morning to ensure that the cash and chips were properly counted and balanced. So if you see someone in a suit and tie going round with a clipboard during a game counting heads, you know what they're doing! The auditors will (or should) have questioned the directors on key matters, where required and their answers will be reflected in these accounts. I'll talk about some of the accounting policies in subsequent articles but at this point will say that there can be many different ways to represent the financial situation of a transaction or asset and these can have a material impact on the figures. Therefore it is important that an appropriate policy is used.
Finally the auditors express their opinion that, in this case, the accounts fairly represent our financial situation. This is not an absolute, cast-iron guarantee that things are OK though as a board determined to misrepresent their figures (e.g. Enron) will do so. KPMG (one of my former employers, I should add) are one of the biggest and most reputable accountancy firms in the world but even they can get things wrong. They signed off the accounts of another former employer in 2001, just weeks before this company collapsed in a big heap! This is still all subject to legal proceedings so I'd better not say any more. If they do uncover material irregularities then they should say so in the auditor's report but someone adding up their expenses wrong is not usually going to affect anything to any great degree.
The auditors are engaged by the directors but carry out their work on behalf of the shareholders, who have to formally re-elect them every year at the AGM. They can also be changed by the directors if they feel the situation warrants it. It is most important that the external auditors are seen to be independent of the directors. Therefore it would not be appropriate for a close relative of one of the directors to be responsible for the independent audit. It could be seen as a little surprising that the Manchester office of KPMG is the one which carries out our audit, as this could involve City fans on the auditors' staff having access to details that other fans don't, even though they have a strict duty of confidentiality. However, when I think about it, if we were to use the London office there is the danger that too many Manchester United fans could potentially be poking their noses into our books so, on the whole, it's probably safer using the local office.
The rest of the report contains the real meat and bones, i.e. the figures. I'm going to cover each section in detail in subsequent articles but there are the accounts themselves, consisting of three financial statements, plus the associated notes. The financial statements follow a prescribed format. The first (Page 17) is the Profit and Loss Account and this shows our total income and expenses during the year under review, together with the equivalent figures for the previous year (Page 18 is to do with property valuations and their impact on our profit or loss).
The second major financial statement (Page 19) is the Balance Sheet and this shows our assets (i.e. the things we own or are owed) against our liabilities (the things we owe to others). The third and final statement is the Cash Flow Statement. This reveals how much cash we actually generated or consumed in total in the year. I'll discuss this in more detail later in the series but it is important to be aware that a company can report healthy profits but not actually generate any cash and, for a football club, cash is crucial as we need it to fund transfers. In some ways it is the most important and revealing of the three statements.
If you have a copy of the accounts or are viewing them on-line, you will see a column called "Notes" in all three statements and figures in this column. These are references to the final section which, not surprisingly, is the Notes to the accounts (Pages 21-38). They say the devil is in the detail and this section is the Underworld. There are explanations of the accounting policies adopted and more detailed explanations of some of the figures in the accounts. Therefore you will find in here how our turnover is split between gate receipts, TV income and other income, plus many other items of interest, including details of our debts and how we pay for the stadium.
So that is the Annual Report. When this has been issued and shareholders have had some time to digest it, it forms one of the central parts of the Annual General Meeting. This is a statutory meeting where the shareholders are invited to attend and have the chance to question the board and generally takes place in December at CoMS. Typically there will be a number of formal pieces of business:
As far as the voting is concerned, you can (if a shareholder) turn up in person and a few hundred did last year. You can request that your vote is cast a certain way or that someone else has the ability to cast a vote on your behalf as they see fit. As I said, this is the one real chance you get as a shareholder to question the board and hear what they have to say and the City AGM has been the scene of many a verbal bloodbath in the past!
At the last AGM, Stuart Pearce gave a short speech about the playing side and answered some questions but no discussion of individual players and their contracts is allowed. Finally there was an open Q&A session but it only lasted half-an-hour. The questions range from the serious (the SWP transfer) to the banal. The board should come out of this session feeling they've been put through a mangle but have succeeded in justifying their actions to shareholders. They had a very easy ride in 2005 but hopefully, with all this knowledge MCIVTA readers will have, they will have to earn their money at the next AGM.
In the next article I will be discussing the financial situation regarding CoMS and analysing our debts. I think I can assure you of a fascinating read!
Part 3 : The Stadium & Those Debts
I was originally going to do this as the last article in my series but there are so many important issues surrounding these that affect the articles on the financial statements that I decided to move it up the list.
We've undoubtedly got a stadium that is the envy of many clubs around the world. I still get a thrill when I get anywhere near it. It's sad, I know, and the feeling has usually evaporated 90 minutes later. But how did we come by it, what happened to Maine Road, who actually owns CoMS and what does it cost us?
Our dear friends from Salford call it "the Council House" but that simply betrays their lack of sophistication in financial (and any other) matters. The truth is that the stadium is operated under something called a "finance lease". Accounting standards define this as a lease which, to all intents and purposes, confers the risks and benefits of ownership. So when they talk about "the Council House", refer them to SSAP 21, the accounting standard on the treatment of leases (you could also tell them that it will be a useful exercise for when Glazer sells the Swamp and leases it back, as he undoubtedly will). We account for the income and are responsible for repairs and for the fittings, although there are restrictions in the lease over what we can and can't do. Hence we have seen all the fuss over signage and general customisation.
The lease can be looked at as Manchester City Council (the lessor) lending us (the lessee) the money to buy the stadium. They haven't actually given us the cash in hand and we haven't actually bought it but we pay it back with interest as though they had. Obviously this is a totally different situation to a council house, where you just pay rent. Maine Road was effectively a down-payment. We handed it over to the council in part exchange for CoMS and they "lent" us the difference. However, we still don't actually own the stadium and, as far as I am aware, never will. We have a 250 year lease on the stadium but its useful life is much shorter than this, maybe about 50 years.
After the Commonwealth Games in 2002 and once the remaining construction work had been done to put in the extra tier and build the North Stand (which was not our responsibility I believe) it needed fitting out with all the offices, bars, turnstiles and executive boxes that make a modern stadium and we had to pay for that. It has been reported that this cost around £20 million.
So how do we pay for it? We have agreed a formula with the Council that allows us to keep all the gate receipts up to the capacity of Maine Road, that is, 34,000. After that, we pay them based on attendances over that amount. This includes non-football events as well. I don't know what that formula is so I can't tell you what the split is and whether it applies to the gross income or we are allowed to deduct expenses. But whatever it is the higher our crowds, we more we pay.
There are other financial implications. We have to set up an accounting entry that represents the total money we think we will be paying over the life of the lease and depends on a number of factors such as crowds, the rate of inflation and interest rates. On Page 28 of the 2005 Report is a table that illustrates this. You will see, if you read the notes above it, that we have assumed average attendance of 42,500 in making this calculation, as well as 2.5% inflation. The stadium was independently valued in May 2004 at just under £150 million in that year's accounts.
I mentioned that the lease is like a loan and includes interest. This is shown as an expense in the Profit & Loss Account whereas the non-interest element goes to reduce our total liability over the life of the lease. Just to illustrate this, suppose we have an outstanding lease at the start of the year of £30 million. We pay 5% interest of £1.5 million during the year, which will be shown as an expense in the Profit & Loss Account and will increase the total debt to £31.5 million. We actually pay £2.5 million in total in lease charges during the year, which reduces our total liability to £29 million. Therefore we have reduced it by £1 million, which is the total payment of £2.5 million less the interest of £1.5 million.
The interesting thing to come out of all this is the overall effect on our finances. We treat the stadium as though we own it (even though we don't) and show it at its full value in the balance sheet. This is the correct treatment according to the accepted accounting standard. Therefore we have gone from owning a stadium worth about £30 million to "owning" a stadium worth £150 million and this has improved our balance sheet enormously. However, even though our accounting treatment is strictly correct, the central question remains - what is it really worth to us if we ceased trading? If we owned the stadium then there would be an asset there to sell but we don't. Were we right to give up a £30 million asset for one possibly worth nothing in practical terms in that way? I simply can't answer this question but it is, I believe, the key to really understanding our true financial situation.
I'll deal with this is the next article on the Balance Sheet but be warned; the implications may shock you.
The one subject above all connected with the finances guaranteed to get us all into a heated debate. So what is the truth - are they as well-structured and manageable as Alistair Mackintosh would have us believe?
First of all, we talk about "our debt" but there are a few different types of debts we have. There are the people we owe money to in the normal course of business - our suppliers of goods and services. We receive an invoice from them and have a certain time to pay it. These are short term debts and as long as we have adequate income coming in then we should be able to pay these. We will also owe tax and national insurance, including VAT. Although these are debts, they are not part of what we refer to as "the debt".
Something else that falls into that category is the debt connected with the lease. As I said above we have to show an estimate of the total payments we would have to make over the life of the lease but this is an accounting entry as we only pay what we owe the council, according to the agreed formula, every three months.
However, when you take these away, we have what most of us think of as the debt, which is the money we have borrowed. There are two main types of borrowings, secured and unsecured. The former means that, in return for the loan the lender has first call over an asset in case you cannot pay it back. The best known form of secured debt is a mortgage, in which your house is security. Unsecured loans mean that the lender has no such security. We have both secured and unsecured borrowings.
The secured loans totalled £43.3 million in the 2005 accounts and consist of two separate loans. The first was for £30.3 million and is repayable over 25 years at 7.27%. The second was originally for £13.7 million and is repayable over 15 years at a rate of 7.57%. Of this latter loan, £700,000 was repaid during the year, leaving £13 million. My best guess is that these will cost us somewhere around £5 million a year to service until the fifteen year loan is repaid, then about £3 million a year for the next ten years.
I said that these were secured loans and the next question should be - what are they secured on? Normally it would be our stadium but, as you now know, we don't own that. The answer is that they are secured on our future ticket income. This is an increasingly common financial instrument used by companies than lack the necessary assets for more conventional security. David Bowie did something similar, pledging his future royalties against a cash sum in advance.
Now, in order to agree to this, the financial institutions involved would have to have some confidence that these future income streams can be maintained at a respectable level. This is where the famously loyal City support comes in. Crowds of 28,000, even when we were in what is now League 1 convinced them that we could continue to pull in the cash whatever. Another element of this is that our payments are fixed over the life of the loan so all things being equal and assuming that inflation, ticket prices and TV income will rise over time means that paying £5 million in ten years will not have the same impact as paying £5 million this year.
The down side of all this is that if our income were to fall significantly then we are still committed to paying, before we pay anything else. So if we continue in the Premiership and continue to pull in the crowds then there is no great problem paying out £5 million from an income of over £60 million. However, that's not to say that we couldn't find better things to spend £5 million a year on (such as a striker who can actually score). But if things go disastrously wrong on the field and we lose a large chunk of our income from crowds and TV then spending £5 million a year from a much lower income base gives us a potential problem.
So what were these loans spent on? The club is keen to stress that £20 million went on the fixtures and fittings for CoMS but is less keen to publicise that the rest probably went on players. The basic rule of finance is borrow long term to buy long term but never borrow long term to buy short term assets. This means that it's OK to borrow money over the long term if you're spending it on an asset that will provide a return over that term. However it's not OK to borrow money long term to buy an asset that only has a short life. So, you shouldn't get a 25 year mortgage just to pay for a holiday, for example. Yet we took a long-term loan to finance player purchases, so we will be paying for these players for 15 or 25 years yet most have them have already gone. So that's not such good business but what's done is done.
The final debt is the one that we really need to look at and these are the unsecured loans from Messrs Wardle and Makin. The club calls these "soft" loans (and that's not a comment on Wardle and Makin for making them). It refers to the fact that, unlike the secured loans that we pay instalments on annually, there is no repayment plan in place for these to be repaid. However, I did discover, on examining the 2003 accounts, that we owed Wardle £5.7 million at that time and supposedly had a plan in place to pay this back over 12 quarterly instalments. Yet in 2004 this had seemingly been ditched, suggesting we couldn't afford the £2 million a year it would take.
However, the loans are not so soft that they don't attract interest. There's nothing wrong with this, by the way, as the lenders are entitled to some reward for their risk. Interest is at a very reasonable 5% and some or all of it is still owed to them. There are things I could criticise Wardle over but not his generosity. We have really relied on these loans to stay in business, as you will see when I talk about Cash Flow in a later article. Furthermore, if we were to cease trading they might not see some or all of that money again.
In the 2005 Accounts you will find the details of the loans on page 31 in note 17. The loans from Wardle total £14.7 million with just under £4.5 million from Makin. You will notice that Wardle's loan has increased from £7.7 million the year before. Therefore he has pumped a further £7 million in during the financial year (our bank balance is also just over £7 million by the way so the obvious conclusion is that it is the additional £7 million sitting in the bank and it went in close to the year end). So that's £19.2 million we owe these two.
So add the £43.3 million to the £19.2 million and we have total ongoing debt, excluding trade creditors and the lease, of £62.5 million. We also had an outstanding amount of £2.2 million (which wasn't repaid until July 2005) and other loans totalling £1.25 million. So, strictly speaking our unsecured lending was £22.65 million as at May 2005 (although this would have been down to £20.4 million in July, assuming no other debt had been taken on). So when I asked you what you thought our total borrowings were in the last article, you should have come up with a total of £65.95 million, as against £62.2 million the previous year.
But the club did a very effective PR job in convincing people that debt had actually been reduced over the year. In fact, if you look at the Chairman's Report on Page 4 under Financial Performance, the last sentence of the third paragraph says "Total debt... has fallen to £57.7m". So is our chairman telling porkies? Well, not really, but he is being very selective. The £57.7 million is "net of cash" which means that he has knocked off the near £7.5 million we've got in the bank. At least we had it in the bank on 31 May 2005 - if we spent it the next day our net debt on 1 June could well have been back to nearly £66 million. And you would have to be some accountant or PR person to prove that £62 million had "fallen" to £66 million.
So what was all that in the Chairman's report about net external debt falling from £50 million to £38.5 million? When Wardle talks about external debt he means that owed to third parties i.e. not to him or Makin as shareholders. Therefore the £50 million in 2004 was made up of the £44 million secured loans, another loan of £4.4 million (which has since been repaid in two instalments) and £1.6 million we owed the bank via our overdraft.
On that basis the £38.5 million is therefore the £43.3 million of secured loans (we paid off £700,000), and the £2.2 million still outstanding on the other unspecified loan at that time. But, I hear you cry, that's £45.5 million and you are not wrong. However, once again he has knocked off the £7 million plus in the bank on 31 May 2005. The same question applies; was it still in the bank on 1 June? We will find out shortly.
Now, what do you understand by the word "manageable"? I take it to mean that I can deal with something, it's within my control. Alistair Mackintosh constantly assures us that this unsecured debt in "manageable". So what does he mean by that? He means that it's within our control because Wardle and Makin aren't asking for it back, either all at once or in instalments. Which is just as well as we only had £7 million in the bank at the end of May 2005 and this is somewhat less than £19.2 million. It did occur to me that perhaps they don't want it back yet because they know we can't pay it. I will try that one with the mortgage company if ever I can't pay; "There's no problem - if you don't ask me for it back it's quite manageable".
So if they did want it back all in one go then we would have to find the money from elsewhere. Like, by selling our most valuable player(s), for example. But I'm sure the board wouldn't do that. It will be interesting to see what our unsecured debt is in the forthcoming accounts. So if you are one of those calling for Wardle to resign, could you replace the £14.7 million that he would take with him? Because if you couldn't we would probably be in a really serious mess.
So are our debts well structured and manageable - Yes Or No? I'll leave it to you to decide but hopefully you can't now say that you are a "Don't Know".
In the next instalment I'll look at the first of the actual Financial Statements, the Profit & Loss Account. We're one of the top twenty European clubs by income but couldn't apparently afford a couple of million for Thomert. So what do we spend it all on?
Part 4 : 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 £7 million in our account and that it was probably the extra £7 million 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 (£15 million) 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 £1 million 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 £2 million. 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 £30 million 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 £3.5 million 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 £6 million on a 3-year contract, we charge £2 million amortisation to the accounts for each of those three years. The large figure of over £11.5 million 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 £8 million. It's important to remember though 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 £6 million player on a three year contract, we have already said we would charge £2 million per year. Therefore if we sell him at the end of his second year for £3 million it looks like, on the surface, we have lost £3 million. However, in accounting terms we have actually made a profit of £1 million. How come? Well, we've charged two lots of amortisation (2 x £2 million), which totals £4 million and this reduces his accounting value to £2 million (£6 million cost - £4 million 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 £15.5 million but that doesn't mean we've spent £15.5 million more cash than we received in income. £11.5 million 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 £21 million 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.
Part 5 : 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 though 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 and long term) plus capital and reserves.
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 (£11 million Intangible Assets and £156.8 million 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 £55 million! 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 (£1.3 million in this case) and then the original cost of any players sold during the year (£19.75 million). 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 £36 million) 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 £11 million. 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.
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 up front 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.
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 £50 million 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 £4.5 million of this relates to some grants we've received and are spread over a number of years. But what is the £16 million? 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 £16 million 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 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 £7 million 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 £7 million 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 54 million of these have actually been issued. The note also shows that there are another 10 million 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 £150 million, Maine Road at £35 million and the future value of lease payments at £35 million, this reserve would be around £80 million. 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 £28.5 million.
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 £140 million 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 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 £42 million. So we can take £98 million out of our assets. Overall then we seem to be about £70 million 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 £11 million for players in the balance sheet but SWP (who wasn't part of this £11 million) was sold for £21 million 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 £61 million.
So that's £50 million more assets than we've accounted for. So without the lease we are probably £20 million 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 would depend on whether we have the right to do that or whether the council would simply take 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.
* 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.
Part 6 : 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 and 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 (£8 million). 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 £6.6 million.
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 and Makin loans. So only the actual interest paid is taken into account, less any interest received. In total this comes to just under £6.7 million 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 £8 million for players and paid out £6.2 million, with just under £1 million 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 £4 million. So the overall position is that we are over £3 million short of the cash we need to get by, even when we've balanced our player sales and purchases. New debt issued of £10.7 million, includes two things. The first is certainly the extra £7 million 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 £7.6 million over the year but pretty well all of this has been introduced by the chairman, via his additional £7 million 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 £7 million 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 year's 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 £15 million, 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 £12 million) is in season ticket renewals and therefore will mostly come in February, March, and 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 £10 million, 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 £7 million 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 and 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 and 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 £15 million 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 Dickens' 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.
Part 7 : Summary
This is (thankfully, you may say) the last in the series on the finances and accounts. I will summarise the position and give you some pointers to what to look for this week when the accounts are published. Before I get into the bones of this final article I'd just like to re-iterate why I did them. There was clearly a desire within parts of the City supporting community to understand the real financial state of the club. Much of this was due to a lack of detailed knowledge of financial issues. Published accounts of public companies are supposed to give investors relevant information on those companies' finances but that only works if you understand what you're looking at. I also understand that many people couldn't care less. I never claimed to be an expert but I admire people that have the ability to simplify a complex subject.
In the first article I talked about the share structure of the club and who the major shareholders are. There are four holders of more than 3% of the company and many smaller shareholders. Since then the price has drifted and you can now buy shares for 24p each and sell for 21p. Anyone can buy the shares, via a stockbroker. The Supporters' Trust have had enquiries about buying the shares and we plan to publish contact details of a stockbroker that has indicated that they will not require a minimum contract value (although there will be a small minimum commission charge). There have been no significant changes in shareholdings or the composition of the board since then.
The next article covered the structure of the annual report and the business of the AGM. I expressed concerns about aspects of the club's corporate governance, namely that our chief executive is a member of the audit committee, in contravention of the major guidelines on the subject. The board had a very easy ride at the last one and while I don't want a return to the friction of the latter days of Peter Swales' reign, the board are there to be challenged.
Next up was an article about the stadium and the debts. The stadium is leased from Manchester City Council and the term of the lease is 250 years. We pay the council on a formula based mainly on attendances in excess of those achieved at Maine Road and the estimated total liability under the terms of the lease is shown in the balance sheet. The stadium is shown in the accounts as though we own it and this is correct under the applicable accounting standard. However, there are many unanswered questions about this topic and neither the club nor the council seem in a hurry to expand our knowledge.
I told you that we have two main sources of borrowing. The first is two long term loans secured on our future income streams and these are being paid back over 15 and 25 years. It was interesting to note that in his recent podcast, Alistair Mackintosh was saying that we have used the stadium for securitisation in contrast to what the accounts say. So there's a question for the AGM.
The other source of borrowing is the loans from John Wardle and David Makin, totalling £19.2 million. These attract interest but we don't pay it. John Wardle had to introduce an additional £7 million during the previous year and the suggestion is that this was required to replace the season ticket money that had to be ring-fenced and therefore we couldn't use for operational purposes. This ring-fenced money was offset against our total debt but I would query whether this was really appropriate as much of the £7 million would be used to pay interest, rather than capital. So apart from a repayment of £2.2 million, being the first of two repayments of another outstanding debt, and £700,000 paid off one of the secured debts, our debts weren't reduced. In fact they effectively increased with the introduction of the extra £7 million by John Wardle.
The fourth article looked at the Profit & Loss account and analysed the three main sources of income. Ticket receipts are actually third, behind TV and commercial income. Our wages were £37.7 million and around 62% of turnover. This is generally regarded as on the high side of acceptable in the crazy scheme of things in modern football but this was the sixth highest figure in the Premiership and we certainly didn't see that translate into top six performance. I also explained the difference between cash and accounting transactions and tried to explain the concept of depreciation/amortisation. I also explained how we calculate the profit or loss on the sale of players and that, although we showed a large loss, this is not necessarily disastrous in the larger scheme of things.
In the fifth article on the Balance Sheet, I showed how the different types of assets and liabilities were set out and what some of the figures meant. The nature of how assets and liabilities were accounted for, which may not relate to their "true" value. Football clubs' assets don't reflect the market value of players so this can be misleading. Also the treatment of the stadium as though we own it tends to skew the balance sheet. Ideally, I would like the club to give us a clear and unequivocal statement about the actual value of the lease to us and what we can and can't do with it. This could have a crucial bearing on our true financial position and as whether our actual asset value was greater or less than the value of our liabilities.
Finally, there was the cash flow situation. I explained that despite our huge £60 million income we struggled to generate any net cash and therefore this prejudiced our ability to sign players where the deal involved large cash payments. In a very speculative piece, I also made the assertion that I believed our day-to-day cash flow meant we had to renew season tickets so early as we were short of cash by that time and, if I was right, this could be a major problem if we were in trouble at that time and many people were reluctant to renew.
If you want a really good bullet point summary of the 2005 figures, please read David Hamer's report in MCIVTA 1186.
So that's a brief look back but what about the accounts we should see this week? I hope they're better than the performance against Wigan.
I will be doing something on these when they see the light of day but would encourage everyone to have a good look themselves and ask questions, based on what you hopefully now know. What should you be looking for?
Read the Chairman's Statement carefully. He talked about the proceeds of the SWP sale in 2005 (even though it was in the following financial year). There were clues even then that investment in the squad and reduction of the unsecured debt were not high on the list and that much of the cash might well be spent on more mundane purposes. He should be spelling that out in detail this year, as well as telling us what the board's strategy is going forward.
Something else to look for will be in the Directors' Report. Look for the make up of the Audit Committee, which should consist of two, suitably qualified, independent non-executive directors. If one of those is still Alistair Mackintosh then serious questions need to be asked of the board and our auditors. I know I am not alone in being concerned about this. I have heard that the board consider that they have sufficient numbers and experience to do their job but if they can't find a suitably qualified non-executive to sit on the Audit Committee then they clearly haven't.
The accounts should show an overall profit but this will be mostly due to the sale of SWP for a guaranteed £21 million. This is pure profit as he cost us nothing. Take that out and see where that leaves us. Look at operating profit and the breakdown of income and the level of wages. Fowler, McManaman, Bosvelt, Tarnat, and Anelka all left before or during the financial year and you would expect the wage bill to have been reduced significantly. But comments from Mackintosh recently suggest it hasn't, so where's the money going?
Compare gate and commercial income to the previous year. It wouldn't surprise me if gate income has fallen. Now any normal business seeing their receipts fall would reduce prices or otherwise offer better value to attract customers. But what do football clubs do - increase prices, that's what. City also angered season ticket holders like me by stopping our exclusive period for claiming cup tickets.
The level of debt is clearly a key item of concern. What we need to know is how much we still owe Wardle and Makin. Last year it was £14.7 million to Wardle and £4.5 million to Makin. The big question is whether any of the SWP money has been used to repay any part of these loans. This can be easier said than done but the answers can be found in the note on Borrowings listed under Shareholder Loans so read these carefully.
Finally, look at the cash flow statement. We had a huge influx from the SWP sale so take that out to see how we actually did over the year. It is a complicated statement to read but you need to work out how much cash we have generated (and it should include the SWP money so take that out) and how much of that has been because we managed our money well or because it had to be introduced via loans or other external financing.
I hoped you have enjoyed these articles. I've had direct and indirect feedback from a great number of people. That has ranged from the "So what" camp (thank you Mr Heavis) to some that claimed my articles were too simplistic. The latter charge has a ring of truth to it but I don't have the knowledge to satisfy people in that camp and it wasn't aimed at them anyway. But most has been supportive and appreciative and if I've helped just a few people to cast a more informed eye over our accounts then I've achieved what I set out to do. I may well have got things totally wrong or missed something obvious and, in one case at least, I jumped to an incorrect conclusion until corrected but I never promised you that I was a financial wizard.
I also started these well before I got involved with the attempt to form a supporters' trust and these articles are totally separate from that activity. However, there is a clear connection between the two. As a supporter and shareholder I want to understand what the board are doing to bring success (or avoid failure) and how we are building for the future. If I believe that the board is doing the best it can for my club then I will support them wholeheartedly and so should we all. I would love to be able to walk away from the AGM thinking that the board had been giving a good grilling but had succeeded in convincing us that they were on the right path. So December 7th (as I hear the AGM will be) should be interesting.
My sincere thanks to those who took the time to read and disseminate them and also to the handful of people who really helped me to understand what I was looking at. And, of course, to MCIVTA for publishing them.
Colin Savage <colin(at)cjsavage.co.uk>