Finance and Football Clubs : What Cash Flow Analysis Reveals

by B.J. Webb and J.M. Broadbent The precarious position of Football League Club finances has been highlighted by extensive press coverage(l) and has given concern to the Football League(2). It is our contention that the use of "traditional" financial reporting practices has hindered full understanding and consideration of the causes and indicators of clubs' financial difficulties. The first part of this article considers the objectives of financial reporting, and the view that these are best met by cash-flow information; the second part reports on the results of an empirical investigation of a sample of Football Club accounts and assesses the informational value of a cash flow approach. The Objectives of Financial Reporting "The fundamental objective... is to communicate economic measurements of, and information about, the resources and performance of the reporting entity useful to those having reasonable rights to such information."(3) The Sandilands Committee Report argued in similar vein(4) and identified a range of users of information whose needs should be addressed. Carsberg, Hope and Scapens hypothesised that the objectives of information and the decisions to be made by users could be summarised as in Table 1(5). The characteristics and objectives of football clubs, however, differ from those of orthodox commercial organisations. They are not primarily profit oriented and can be seen as promoting the maximisation of football success whilst maintaining a level of financial security(6), or as maximising utility(7). This suggests that the information requirements of interested parties are likely to differ from those identified in Table 1. Shareholders: Football clubs are essentially small private companies, where control is highly centralised. FIR(8) found that over 60% of clubs were under the effective control of the directors (i.e. 40% shareholding or more) and that substantial restrictions on the transferability of shares were common in the industry. In the absence of a ready market for shares, and with dividend restrictions imposed by the Football League, the opportunity for capital gain or future income is severely curtailed. Shareholders in football clubs must therefore be presumed to have invested for other, non-monetary, reasons e.g. to maximise their psychic income from involvement with a successful, important or local team. The "buy, hold or sell" decision is largely inappropriate in such circumstances, the market cannot act as a constraint or regulator of financial resources, and as such traditional economic models are of limited assistance in building a realistic framework for analysis. Consequently, the cost of capital and investment decisions become clouded as no real quantifiable opportunity cost exists. Other Clubs: The Football League is characterised by onfield competition but off-field interdependence. Competitors must continue to exist in order to provide opposition. Other clubs are also essential suppliers of, and customers for, players through the transfer system. There are signs that clubs are increasingly unwilling to corn6 Table 1: The Provision of Information to Those Interested in the Financial Affairs of Commercial Organisations (Source - Carsberg et al (5)) 1. The provision of information to shareholders (actual and potential) to guide their investment decisions, i.e. decisions on whether to buy, hold, or sell securities. 2. The provision of information to inform shareholders of the uses to which their funds have been applied and the legality of those uses with a view to enabling the shareholders to exercise any legal remedies available. 3. The provision of information to guide creditors (long-term and short-term) in decisions on the allowance of future credit and the administration of existing indebtedness. 4. The provision of information to employees to guide their decisions on future relationships with the undertaking. 5. The provision of information to managers to enable them to take efficient decisions in management. 6. The provision of information to the representatives of society to enable them to judge whether the activities of the undertaking are consistent with national objectives. 7. The provision of information to guide government officials in the assessment of taxation. 8. The provision of information to guide government officials in the enforcement of statutory controls. 9. The provision of information tofinancialinstitutions to assist in the negotiation of financial facilities. promise their own cash flows by offering extended credit for the payment of transfer fees(9), and that ability to pay is likely to become an important element in transfer negotiations. Spectators and the community: While all 92 Football League clubs have legal status as limited companies their function in the community is much more akin to that of a social club or church. Without the support of the community the club would lose its (paying) congregation; without the club the community would lose an emotional and economic focus. The relationship was amply demonstrated during Sunderland's 1973 FA Cup run which completely captured the local imagination. Each needs the other, and each should take the needs of the other into account when making strategic decisions. Employees: The labour market in professional football is unique; professional footballers face unusual restrictions and also possess greater opportunity to negotiate terms of employment than do most employees(10). It is correspondingly important that full information is available to enable

players to decide whether to play for a given club and on what terms. Although employee reporting has become more popular, football clubs do not provide information specifically oriented towards their employees' needs. Other Groups: For the most part suppliers of goods, lenders and others may be assumed to make similar decisions about their relationship with football clubs as with commercial organisations. Directors, however, make interest-free loans, an industry anomaly, while the extent of bank commitment to football clubs seems unrelated to normal banking criteria. A modified decision profile for those having dealings with football clubs is summarised in Table 2 which may be compared with Table 1. We contend that all the users detailed have a 'reasonable right' to receive from clubs information which is useful and relevant to their decisions concerning their relationship with the clubs, and that clubs' ability to attract funds, customers and employees may well be inhibited by the way they have traditionally presented financial information. Table 2: The Provision of Information to Those Interested in the Financial Affairs of Football Clubs 1. The provision of information to shareholders to inform them about financial support for football ambition so that shareholders may exercise any possible influence upon management. 2. The provision of information to inform shareholders of the uses to which their funds have been applied and the legality of those uses with a view to enabling the shareholders to exercise any legal remedies available. The provision of information to guide creditors (long-term and short-term) in decisions on the allowance of future credit and the administration of existing indebtedness. The provision of information to players and other employees to guide their decisions on future relationships with the club. The provision of information to managers to enable them to take efficient decisions in management. The provision of information to spectators and the community to enable them to judge whether the club requires financial or other support. The provision of information to guide the Football League in its regulation of the industry. The provision of information to financial institutions to assist in the negotiation of financial facilities.

football clubs could ever satisfy that criterion. None of the user decisions identified in Table 2 requires information about profit or return on capital employed as a direct input. Profit is an accounting concept, encompassing a mixture of complete and incomplete transactions, and the result is dependent upon the treatment and classification of unusual items, e.g. the sale of investments or donations from supporters. Its use as a reliable indicator of past events or predictor of future events must be doubted when "the 1968 profits of so large a company - Pergamon Press - which were solemnly audited as 2.1 million by one respected firm of accountants are now said to have been only 495,000, and that a cautionary rider should be applied to 355,000 of them!"(12). While the Accounting Standards which followed the Pergamon scandal have limited some of the possible approaches to profit measurement, they have not made the classification of unusual items significantly easier. We have argued that profit is an irrelevant and potentially misleading concept for the users of the financial information of football clubs. Further, we have suggested that such users are interested in financial affairs only in so far as they underly the club's ability to survive and strive for football success. The most appropriate financial reporting system would therefore be one which is factual, understandable and relevant (i.e. indicative of the clubs ability to meet obligations and to acquire and keep a successful football team). We contend that the system which best satisfies these criteria is Cash Flow Accounting. Cash Flow Accounting; Some Observations and Research Findings It could be argued that the limitations of Profit and Loss Accounts and Balance Sheets were "officially" recognised in 1975 with the publication of SSAP 10 "Statements of Sources and Application of Funds"(13) which required companies to include such statements with their Annual Report and Accounts. All the user decisions we have identified, in so far as they have a financial perspective, are more strongly related to cash transactions than the accounting concept of funds (cash and credit). A club's capacity to survive, acquire players, pay wages and interest and attract supporters (by way of providing facilities) depends on its cash flow; cash is the one resource which indicates progress and survival. Lee argues that the concept of a dynamic report which details the flows to and from an entity has much appeal, but that "funds flow reports contain one very significant limiting factor - they are based upon the concept of allocation accounting. Thus the flow of funds.... contains all the measurement faults and problems associated with income determination"(14). The reporting of cash flows would directly address the needs of users of football club accounts. Several studies have applied ex post cash flow analysis to individual companies or industry groups. Lee, for example, has suggested that: "If cash flow analysis techniques had been used by the Bankers responsible for the Laker Airways account, they ought to have become worried in 1978 and taken action in 1979.... instead they continued through 1980, 1981 and 1982"(15). Lawson analysed the reports of F.W. Woolworth for the five years to 1982 observing that "the principal inference is that accounting numbers have some seriously misleading properties"(16), while Webb and Arnold reached a similar conclusion from an analysis of the affairs of Pergamon between 1964 and 1982(17). Webb, in a study of failure in the construction industry, found that accruals accounting had a significant capacity to mislead; thus while the industry was shown to have significant cash flow problems, 7

3.

4.

5. 6.

7. 8.

Useful Information To be useful, information should be reliable and relevant to the decision being considered. The absence of either characteristic will render the information useless for the purpose required. Arnold and Hope predicated that most user decisions relate to future events and that it was therefore logical, relevant and useful to provide information about the future (e.g. cash flow forecasts)(ll). In the absence of forecasts (which are rarely provided, even by the largest commercial organisation) users have a right to expect that information about the past will, at the very least, be capable of use as a predictive tool. We doubt that traditional profit and loss accounts and balance sheets for

75% of companies surveyed reported profits in each of the years analysed, and the other 25% only reported losses in the year immediately prior to failure(18). Previous studies have amply demonstrated that ex post cash flow analysis can reveal significant features of corporate activity which are of immediate and major concern to interested parties. It is our view that cash flow statements should at the very least, replace funds flow statements in corporate reports (including those of football clubs) so as to provide relevant and reliable information for user decision making. In view of the unusual characteristics and objectives of football clubs we feel that such an approach would be particularly suitable, and we report on the results of such an analysis in the next section. Cash Flow Analysis of Football Clubs Since 1976 most companies (including football clubs) have reported a Funds Flow Statement as required by SSAP 10 which normally follows the form: (P + E + B(l)) - (I + T + D + B(2) + W) = C Where P = profit before tax and after adjustment for extraordinary items and non cash items such as depreciation; E = share issues; B(l) = additional medium and long term borrowing; I = net long term investment in assets; T = tax payments; D = dividend payments; B(2) = redemption of long and medium term debt; W = changes in working capital and C = the change in net liquid funds. This can be readily altered into an approximate cash flow statement by adjusting profit for changes in working capital (i.e. for incomplete transactions). In this way problems of asset valuation and income allocation inherent in working capital determination are avoided. Lee suggests that the format of presentation of the cash flow statement should reflect how the pool of cash has been generated and on what it has been spent, as in: O+E+B+X=I+T+B+C Where O = Profit before extraordinary items changes in working capital (i.e. operating cash flows); X = extraordinary items; and where O, B, X and C could be either sources or outflows of cash and would be positioned on the left or right hand side of the equation accordingly. Football Clubs rarely pay tax and dividends; the former because many clubs make losses (often due to substantial transfer fees), the latter largely because of dividend restriction. In the few cases where they have arisen we have set them off against operating cash flows (redefined as O(l)). Extraordinary items are harder to define. Most clubs include gains or losses on player transfers within the body of the profit and loss account, but it is impossible to determine the cash element thereof because transfer fee creditors and debtors are not separately identified. We have therefore reluctantly included transfer fees in O(l). The receipt of cash donations, however, was separately identified in most reports, although treatment in the accounts varied greatly between clubs (see note (2) Table 4). We therefore decided to present donations in a consistent manner as a separately itemised flow, X, in the analysis, giving the format: O(l) + E + B + X = I + C Cash flow analysis does not smooth cash payments and receipts, so annual cash flow statements are therefore likely to exhibit a more 'lumpy' pattern, especially with transfer fees; matched income statements are likely to be smoother. This does not negate the approach (indeed it reinforces one's doubt about the informational content of the latter), but trends in liquidity will be more readily discernible from an aggregation of several years' flows. Lee

suggests that an optimum aggregate period would be three years, and that trend analysis should be applied to three year rolling aggregates. Where 'lumpiness' of investment is more severe, he suggests that the rolling aggregates may need to be four or even five years long. We decided to base our analysis on a four year aggregate period.

Sample Selection All 92 Football League clubs were asked to provide copies of their Annual Report and Accounts for afiveyear period to 1979 (preceding the well-publicisedfinancialcrisis of the early 1980's). 12 clubs indicated that they would not be able to supply their Annual Reports, and 26 sent copies as requested. There were 54 nil replies. Of the 26 copies supplied, one was rejected because it did not contain funds flow data for the required period to 1979, leaving 25 usable sets. A breakdown of the respondent clubs is given in Table 3. Table 3: Analysis of Sample by Division End 1976 Season Number of Clubs Division 1 2 3 4 9 8 5 3 25

The 12 clubs who were unable to supply their accounts were explicit as to their reasons; 4 had insufficient copies available, but the rest did not wish to make such information available: e.g. "this is a private company and it is not our practice to distribute copies of our accounts." (Charlton Athletic) "It is the policy of the Board to only make accounts available to shareholders and the various statutory bodies who by law require to see a copy." (Ipswich Town)

and

We are unable to draw firm conclusions from the 54 nil replies but it is clear that many football clubs view shareholders as the only users having a reasonable right to receive information. While this may be consistent with the approach taken by other small private commercial organisations, we contend that it is inconsistent with the unique social and economic role assumed (and desired) by football clubs.

Results In Tables 4 and 5 we report our findings using the framework identified above; the Tables are not strictly comparable in that positive and negative flows for "net operating cash flow" and "increase (decrease) in liquidity" have been netted off by division in Table 4. Not surprisingly, clubs in a higher division had a healthier cash flow than other clubs; most of their cash flow was generated from operations, whereas clubs in lower divisions typically made good their operating cash deficit by donations. In this particularly risky industry we would have expected long term finance to be raised as a major source of capital. The recent public quotation by Tottenham Hotspur (which was substantially oversubscribed) indicates that there is a market for football club equity among local businessmen and supporters for whatever investment or psychic motive. Few clubs raised long term finance, most of these were in the lower divisions, and only one club (Manchester United) had a major share issue in the period under consideration. These findings are, however, consistent with the suggestion that clubs are under the strict control of directors who do not wish to dilute their influence(8). We believe that the extent of donations as a source of cash is understated (because of the lack of disclosure by some clubs). It is clear, however, that donations form a major, if not the major, source of cash for clubs in all divisions. Without donations it is reasonable to suggest that clubs in the lower divisions would simply cease to exist. Grants received under the terms of the Football Grounds Improvement Trust are an important source of cash for major clubs (to whom the Safety of Sports Grounds Act 1975 applies) and can be related to the expenditure on

Grounds by those clubs. As might be expected, expenditure on fixed assets by clubs in lower divisions is at a minimum. The most surprising finding, in view of all the publicity about club Finances and borrowings(20), is that there is a general improvement in liquidity (or reduction in overdraft) across all divisions, although this was more apparent in Divisions One and Two. (Only 6 clubs, 4 from the lower divisions, increased their overdraft during the period.) This implies that respondent clubs were successful to some extent in their general objective of maintaining a level of financial stability as a basis for football achievement. Conclusions We have noted that there are divergent treatments of donations, (see Note 2, Table 4) and transfer expenditure and income, which reinforces our belief that traditional reporting is liable to mislead. We also doubt whether the resultant accounts can meet the objectives of financial reporting for any business and specifically for football clubs. We contend that cash flow accounting, extended perhaps to cover the detailed flows to and from football clubs, is not only relevant to users, but less likely to be manipulated or misunderstood. Football clubs are dependent upon local support through the turnstiles, through lotteries and donations, and through local business. It seems very strange that clubs do not issue equity to this local support so as to encourage wider participation and to provide a more stable financial base. We found no significant reference to directors' financial support (through new equity or debt) - clubs relied extensively on donations and cash from operations (particularly in the First and Second Divisions). We are forced to surmise that directors prefer local support to provide cash without strings and thus enforce a form of internal capital rationing so as to maintain their own control.

Table 4: Football Clubs Aggregate Cash Flows 1976-79 Division 1 '000 Sources of Cash (1) Net Op. Cash Flow Equity Long & Med. Debt Donations (2) Grants 2,296 987 69 2,248 835 6,435 Applications of Cash Net Invest. Assets Borrowing Repaid Negative Cash Flows Increase in Liquidity 2,655 248 3,532 6,435 Notes: 1. 2. After Tax and Dividends We suspect that donations may be understated. Some larger clubs do not disclose sufficient detail in their Accounts for complete analysis. Where information is given it is subject to extreme variation in disclosure: 14 3 2 9 Deducted from Asset value No mention 1 5 41 4 55 100 1,222 270 1,636 3,128 39 9 52 100 490 52 1,318 264 2,124 23 2 62 13 100 36 15 1 35 13 100 1,434 131 341 1,105 117 3,128 46 4 11 35 4 100 160 516 1,390 58 2,124 8 24 65 3 100 % Division 2 '000 % Division 3/4 '000 %

P/L Account Appropriation Reserves

Table 5: Analysis of Clubs by Division and by Cash Flow Percentage Sources of Cash 1-25% Division 2 2 3 2 4 Cash Flow Percentage 26-50% Division 2 51-100% Division 2 3/4 1 2 1 4 1 3 1 4 2 Total Division 2

1 Net Operating Cash Surplus Equity Long & Medium Debt Donations Grants Net Disposal of Assets Reduction in Liquid Funds

3/4

3/4

3/4

2 1 1 2 6 1

1 4 3 2 2 2 1

3 1 1 1

1 1 1

2 -

7 2 1 6 7 1 2

4 3 4 5 4 -

1 5 4 6 2 2 4

Applications of Cash Net Investment in Assets Borrowing Repaid Net Operating Cash Deficit Increase in Liquid Funds 1 3 1 3 6 5 3 5 3 2 2 2 1 8 3 8 8 6 3

2 1

1 -

1 2

1 2

3 1

1 4

1 4

3 3

2 7

4 7

7 4

References 1. See for example: The Guardian, 4.2.82, p.8. 2. See for example: The Football League: Report of the Committee of Enquiry into Structure and Finance - The Football League, Chairman Sir Norman Chester, 1983. 3. Accounting Standards Steering Committee, The Corporate Report, 1976. 4. Report of the Inflation Accounting Committee, HMSO 6225, The Sandilands Report, 1975. 5. Carsberg, Hope and Scapens, "The Objectives of Published Accounting Reports", Accounting and Business Research, Summer 1974. 6. See for example: "Report of the Committee on Football", (The Chester Report), D.E.S., 1968, p.33. 7. P.J. Sloane, "The Economics of Professional Football: the football club as a utility maximiser", Scottish Journal of Political Economy, June 1971, pp.121-146. 8. Financial Intelligence and Research, English Football League Clubs - Financial Status and Performance, 1982. 9. E.g. Chesterfield's decision to sue for the transfer fee payable for Alan Birch was the cause of Wolverhampton Wanderers Receivership in 1982. 10. See accompanying papers by R.J. Sutherland and G. Stewart. 11. J. Arnold and A. Hope "Reporting Business Performance", Accounting and Business Research, Spring 1975, p.96. 12. The Economist, August 29, 1970. 13. Accounting Standards Steering Committee, 1975. 14. T.A. Lee, "Income and Value Measurement", (2nd Edition), Nelson, p. 169. 10

15. T.A. Lee, "Laker Airways - the cash flow truth" Accountancy, June 1982,p.ll5. 16. G.H. Lawson, "Was Woohworth Ailing?" The Accountant, Nov.4, 1982, p. 12. 17. A.J. Arnold and B.J. Webb, "Cash, Profits and Pergamon", The Accountant, July 8, 1982, p.28. 18. B.J. Webb, "Failure in the Construction Industry" unpublished discussion paper, Leeds Polytechnic. 19. T.A. Lee, "Towards a Practice of Cash Flow Accounting" Discussion paper 13, University of Edinburgh. 20. See for example, The Observer, 2 September, 1984.