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How much can City spend? There’s no easy answer.

How much can we spend this summer?

I’m often asked the above question on the Bluemoon forum and the answer is generally the same every time I’m asked. “I just don’t know and there is no simple formula to work it out”.

Many people don’t really understand the financial considerations underlying transfers and their impact on the bottom line. So while I may not be able to tell you what our gross or net spend will be, as the summer window starts to come in sight, I can give you an idea of what those considerations are. Let’s work through a player’s financial life-cycle and I’ll demonstrate how the numbers work.

When a club buys a player, the player and club enter into a contract, as do the buying and selling club. That latter contract will detail how much the fee is and any add-ons, such as for appearances, caps, trophies etc. The contract between the club and the player will set out his remuneration and the length of his contract (probably 5 years). Both of these determine how the transfer appears in the buying club’s books.

In Raheem Sterling’s case, we appear to have paid Liverpool a flat fee of £44m, probably payable in agreed instalments, with an additional £5m being dependent on him hitting certain milestones. As there’s no guarantee any of that £5m will ever be paid, the fee put on the books will generally be the initial, guaranteed fee. Up to about 20 years ago, clubs would put the whole fee through their books as an expense so, if that were still the case, we’d be showing an expense in our Profit and Loss Account of £44m. But accounting standards now require clubs to treat transfers differently. The contract between the clubs for the purchase is treated as an ‘intangible asset’ and goes onto the Balance Sheet, in the same way a building or plant and machinery would. It’s described as “intangible” because it’s not the player but his contract that’s the asset.

The issue of valuing players for accounting purposes is a thorny one and accounting principles emphasise prudence in valuing any asset. A player might be worth £80m on the market but the only value shown on his club’s books is whatever they paid for him. That could be nothing if he was club-trained.

As £44m is a bit of a difficult number to work with, let’s round it up to £50m. The buying club has paid £50m for Player A and has given him a 5-year contract. What it then does is charge £10m (£50m divided by 5) to its profit and loss account each year. It’s called ‘amortisation’ and is very similar to the depreciation of a tangible asset like a car. Think of it as the club apportioning the purchase price over the expected life of the asset. All players bought for a fee will have their contracts amortised in the same way. How we actually pay the fee, whether in one chunk or over a period, has no bearing on this process.

Players will be paid wages, bonuses, image rights etc. and these will also go through the P&L Account as expenses. So the player you’ve bought for £50m on a 5-year contract and pay £5m a year to, will effectively cost you £15m a year (£10m amortisation and £5m in wages) and this will be shown in the P&L account. The Balance Sheet will initially show an intangible asset of £50m but that will be reduced by the annual amortisation. At the end of Year 1, £10m will have been charged as amortisation in the P&L account and that £50m will be shown as £40m in the Balance Sheet. Here’s how it works over the 5 years:

howmuch01

At the end of three years, the player will therefore be valued (for accounting purposes) at £20m (known as the ‘book value’) which is the original £50m less three annual amortisation charges of £10m. Now let’s say we agree a new contract of 5 years, to run from that summer (usually July 1st). We start the amortisation process afresh, based on the current book value, which is £20m. So rather than the £10m a year we have been charging to the accounts, we do the calculation based on this amount and the life of the new contract. Let’s say it’s for 4 years. That means the £10m annual amortisation now goes down to £5m a year (£20m divided by 4) and we’ve ‘saved’ £5m a year in expenses. This can be illustrated as follows:

howmuch02

But what if, instead of offering him a new contract, we decide to sell Player A? Let’s say we get £35m for him. We paid £50m and got £35m back so we’ve made a loss of £15m right? Well actually, no, we’ve made a profit and you may ask yourself how that can be possible? The answer is that Player A’s contract is valued at £20m on the balance sheet, as we said above, so we’re selling an asset ‘worth’ £20m for £35m and therefore making a £15m profit. This profit is a one-off of course but it still appears in the P&L account and could therefore be used to absorb the cost of a new player. In addition, there is no further amortisation charge for the sold player, meaning that £10m is released from expenses. Here’s an illustration of how this works:

howmuch03

All things being equal that £10m we’ve freed up can be used to accommodate the purchase of another player. Getting Player B for £50m on a 5-year contract would mean that there is no overall increase in the annual amortisation charge, assuming no other player changes occur. We’d have to pay the new player’s wages of course, so as long as these were no higher than the player we’ve sold, it’s actually cost us nothing in relation to our P&L account. There is the small matter of having received £35m and spent £50m of course, so we have to ensure we can find that additional £15m from our cash resources.

All this buying and selling has a financial impact therefore, which has to be taken into account and which will determine how much we could possibly spend. The other factor will be how much profit or loss we’ve made generally. And not just the current year but for a few years ahead because, if the club goes on a buying spree, it has to be sure future financial performance can sustain that. This is what killed Leeds United, who planned their buying on the premise that they would be in the Champions League every year.

Now, we also have to factor FFP into the equation, so whereas in the early years of ADUG ownership City spent big and the losses reflected that, they now have to ensure that they don’t fall foul of FFP again. So even if we could afford to shell out £500m cash on new players, we’d have an additional amortisation charge of £100m a year to absorb and we’d have to be sure that this wouldn’t impede our ability to pass the FFP tests.

And there are two disparate sets of FFP tests. The UEFA one looks at accumulated profits and losses over a three-year period but aren’t specific about any particular item (e.g. wages) within those. The Premier League ones are more generous in terms of the level of losses allowed but restrict wage growth without commensurate growth in commercial or match-day income. Under these rules you can’t pay higher wages out of TV income. So it’s not just the overall impact on the bottom line but the specific level of wages that have to be considered.

Another issue is having the cash itself to buy players. It’s alright talking about wages and amortisation but we have to have the ability to finance the deal. Having an owner worth billions obviously helps but at some point we’ll want to be able to finance these deals without his largesse. To buy someone like Neymar, with his £140m buy-out clause, means we probably need to pay all that cash up-front so having the resources to do that will come into the equation.

While it’s not directly relevant to potential spend, the issue of net spend should be discussed. As most people know, this is the difference between the amount a club has paid for incoming players and received for outgoing ones. As I showed earlier, you can have a positive net spend but that can have no impact on the bottom line. But a zero net spend may not be quite what it seems. Based on what’s been discussed above, let’s consider an example.

A club sells 5 players for £50m and buys 2 for £50m. Therefore a zero net spend on the surface. But the players sold may include 4 young players, who have come through the academy and therefore don’t attract any amortisation and are on relatively low wages. Let’s say they’re each on £1m per annum. The other player may have been at the club a long time so his amortisation is low (say £2m) and his wages are £3m per annum. So in total that’s £9m off the P&L account in wages and amortisation.

The new players are both on 5 year contracts therefore amortisation alone is £10m per annum. They’re both on £5m per annum wages, making £10m in total. So you’ve reduced expenses by £9m by selling those 5 players but buying another 2 has increased them by £20m, meaning that the ‘zero net spend’ has actually cost an additional £11m per annum.

All these factors taken together make it nigh on impossible to predict a club’s spend with any sort of certainty. To be able to do so you’d need to know:

  • The club’s expected profit/loss situation for a few years ahead;
  • The cost of transfer targets, both in fees and wages;
  • The players you planned to sell, together with their wages and the expected fee range;
  • The club’s cash position.

So ask me again, “How much can we spend this summer?”

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