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Grounds for concern – Column
Tuesday, 14th Dec 2021 17:23 by Simon Dorset

After literally years of speculation, two resolutions on ‘profit and sustainability’ were handed down at Derby and Reading within the space of a few days, prompting our resident FFP expert Simon Dorset to survey the lie of the Championship’s financial land.

After over a year of nothing but rumours and speculation, we were treated to two Profitability and Sustainability resolutions in the space of just two days. Derby County and Reading; two clubs who have explored every avenue conceivable to fund their aspirations to buy their way into the Premier League, and failed. Reading look to be as far away from achieving this as ever, Derby surely League 1 bound.

They are both members of a small clutch of clubs who have sold their ground to another business controlled by their owners. This seems to be a calculated gamble at best but laden with potentially disastrous possibilities should the owner become disillusioned with life as an owner of a football club. I view it more as reckless mis-management which generally only serves to delay the inevitable result of habitual overspending; of the clubs that have chosen this path, only Aston Villa has achieved their objective.

Family silver
ClubSeasonAssetPriceProfitOutcome
Derby2017/18Stadium£81m£40m21 point deduction
Sheff Wed2017/18Stadium£60m£38m6 point deduction
Reading2017/18Stadium£26m£6.5m6 point deduction
Villa2018/19Stadium£57m£36mPromotion
Birmingham2018/19Stadium£23m£17m9 point deduction
Reading2018/19Training ground£13m£8mAs above

To avoid any misunderstanding, the point deductions shown in this table are not as a direct result of any club selling their ground, but because the club went on to breach the P&S upper loss threshold in a later season after the short term injection of both cash and profit had been exhausted.

While this was never technically a loophole in the original Profitability and Sustainability Regulations, a clause has been added into the latest version stating that for any accounting reference period covering the 2021/22 season and later, any profits (or losses) on the disposal of any tangible fixed assets are excluded from the club’s adjusted earnings before tax, which is the figure taken forward to their P&S calculation. Blackburn Rovers were the last club to take advantage of this oversight when they managed to get the sale of their training ground over the line just before the cutoff date of July 1 2021.

A Right Royal Mess

Reading’s recent financial history has not been as well documented as Derby’s, so a brief summary wouldn’t go amiss. Relegated from the Premier League in 2012/13 alongside QPR, Reading received their last parachute payment (£16.3 million) in 2016/17. In May 2017 Renhe Sports Management Company (owned by Dai Yongge and his sister Dai Xiu Li) bought 75% of the shares in Reading Football Club Ltd. The following season the Madejski Stadium was sold to the Renhe Sports Management Company for £26 million and during the 2018/19 season Reading sold their training ground to the same company for any even greater profit of around £8million despite their new training facility at Bearwood Park not being ready.

These one-off boosts to their revenue went some way to compensating for the loss of their parachutes payments, but were swamped by the rise in their payroll costs from £28 million to £41 million over the same period. The inevitable soft registration embargo followed in the summer of 2019 despite a suspiciously large £3million loan fee received from Beijing Renhe for Sone Aluko in their failed attempt to avoid relegation from the Chinese Super League. The second part of their name is an obvious clue as to why it was so generous, the Chinese team is also owned by Renhe Sports Management Company.

Reading paid scant regard to this warning to sort out their finances and, as soon as the embargo was lifted, signed a further seven players including George Puscas from Inter Milan for €8 million making him Reading’s most expensive ever signing surpassing the £5 million they spent on Lucas Joao from Sheffield Wednesday the day before. From that point forwards there was only ever going to be one outcome. UEFA’s directive to temporarily suspend FFP judgements due to the Covid-19 pandemic and to treat the average of the 2019/20 and 2020/21 seasons as one offered Reading a stay of execution, but no more than that.

Their adjusted earnings before tax for the four year period ending with season 2020/21 of £57.8 million exceeds the upper loss threshold by £18.8 million which warrants the full 12 point deduction. The English Football League agreed to suspend 6 of those points until the end of the 2022/23 season on the proviso that Reading comply with some quite stringent conditions which, of course, include a further breach of the upper loss threshold. In future P&S calculations, the losses for the seasons up to and including 2021/22 will be capped at £13 million.

Other conditions that Reading must comply with include a reduction of their total player salary costs to £21.1 million in the current season, and a further reduction to £16 million the season after assuming that they maintain their place in the Championship. Should they be relegated to League One, a new budget in keeping with the current Salary Cost Management Protocol operating in that division will have to be agreed. This is currently 60% of the clubs regular revenue plus 100% of revenue generated from transfers, prize money etc. They also face limits on the size of their squad, the average salary of that squad, the size of any transfer or loan fees paid to sign new players and the total salary paid to them.

Demolition Derby

Even the most cursory glance at the Statement of Affairs recently released by Derby County’s administrator shows how desperate their financial position has become after seasons of systematic overspending by owner Mel Morris. The true picture was masked by the sale of Pride Park to Gellaw Newco 202 Ltd (who are also own by Morris) and their innovative, but uncompliant, method of amortising the capitalised costs of player registrations.

Should anyone want to buy the club, they would have to pay off a £20 million loan from MSD UK Holdings, £28 million to HMRC (who had previously issued a winding up order against the club in January 2020) and outstanding transfer fees of £8.4 million for the privilege. To avoid a further 15 point deduction, they would they have to pay the unsecured creditors 25 pence in the pound within 2 years. The trade creditors total £4.3 million but no longer include the St John Ambulance who had their outstanding £8,300 paid off by an enterprising group of the club’s supporters via crowd funding. It is very hard to envisage any prospective buyer of the club entertaining paying 25% of the £124 million owed to Morris as part of any deal.

For those unfamiliar with amortisation, it is to do with the treatment of the cost of buying players’ registrations. The whole of this cost isn’t immediately debited to the club’s profit and loss. Instead it becomes an intangible asset on the balance sheet and the cost is debited to the profit and loss account equally over the length of his contract. So if a player’s registration was bought for £4m and his contract was for four years, it would be shown as costing the club £1m per season. This is straight line amortisation.

If an asset has a known resale value at the end of its useful life, known as its residual value, it can be amortised down to that value. This is the model that Derby County swapped to for their 2015/16 accounts onwards. However the key element in that methodology is “known resale value”. As I understand the Derby variant, they allocated an expected recovery value to each player i.e. what they expected to receive for that player if he was sold and did so using factors such as his age, availability, form, injury status, perceived market value and whether they expected that the player would be sold and amortised his book value down to that valuation each year. By definition that is a subjective judgement and, therefore, not a known resale value. While this method may potentially track the value of the player more accurately it falls outside of acceptable accounting practice as defined by FRS 102 which is the accounting standard insisted on by the EFL.

Football finance guru Kieran Maguire calculated that Derby had reduced the impact of player registration amortisation by £30 million over three seasons. When this was unravelled it was revealed that they had breached P&S’s upper loss threshold three times in four seasons, the exception being the season in which they sold Pride Park. Before commenting on the overall punishment agreed for these breaches, it is necessary to be aware of the sanctioning guidelines for exceeding the P&S upper loss threshold.

The penalty for breaching of the three season P&S reporting rules is a deduction of 12 points to commence in the season following the breach.

The following number of points shall be deducted from the 12 points
9 points if less than £2.0m
8 points if between £2m and £4m
7 points if between £4m and £6m
6 points if between £6m and £8m
5 points if between £8m and £10m
4 points if between £10m and £12.5m
3 points if between £12.5m and £15m
No deduction if the breach is greater than £15m

Then the balance shall be further reduced if the loss in the final season is less than the season(s) before.

The Guidelines go on to show that a diminishing trend in spending may then be taken into account as demonstrating an intention to comply with the rules. Aggravating and mitigating factors are then available for consideration.

Revised P&S Calculations
Reporting period endingAdjusted earnings before tax lossExcess of upper loss thresholdPoints penalty per tarriff
2016/17£46.76m£7.76m6
2017/18£28.12m--
2018/19£50.72m£11.72m8
2020/21£40.96m£1.96m3
Total--17

The Disciplinary Commission’s decision to dock Derby just nine points (with a further 12 an automatic punishment for entering admin), with another three points suspended, seems very lenient in light of that tariff, but does come with their agreement not to appeal against it and a raft of conditions regarding their future conduct. These include finally resubmitting their revised accounts for 2016, 2017 and 2018 and submitting the late accounts for 2019 and 2020 by 16.00 on January 31, 2022. There is also a requirement to publish all future year’s account by the statutory filing date.

Any changes to their accounting procedures requires the EFL’s agreement, as does applying any player impairments (reducing the book value of a player over and above the annual amortisation) and claiming any exception items in their P&S calculation. In addition, they face squad restrictions similar to Reading. They must pay all wages on time, their salary costs this season must not exceed £15,775,000 along with limits on the size of their squad, the average salary of that squad, the size of any transfer or loan fees paid to sign new players and the total salary paid to them. Should they fail to fulfill any of these stipulations, the suspended three points will be immediately docked from their tally.

While many see this as evidence the P&S is not fit for its purpose, I’m sure that UEFA and the EFL would argue that Derby’s case is actually a vindication of it and a stark warning of the potential outcome of trying to cheat the system. In any of its forms throughout Europe, Financial Fair Play’s stated purpose is to prevent professional football clubs spending more than they earn in the pursuit of success, however they have to understand that any regulations that stifle ambition are just as detrimental to the game as the overspending that they are trying to prevent. A simple change to these regulations to allow owners to inject capital into their clubs would immediately remove the temptation for them to take ridiculous gambles.

What cannot be denied though is that had Morris adhered to its regulations and not sought mechanisms to buck the system Derby County would not now be in administration. His appetite for funding the results of his overspending to the tune of £1.5m to £2m every month soon waned when he started to lose the legal battle with the EFL and now the club he has abandoned is a frighteningly unattractive money pit urgently seeking a new owner. A truly desperate situation.

Also by this author >>> Gordon Jago: Leading From The Front >>> The Trust >>> Accounting for success >>> Gambling with FFP >>> The greater evil >>> Terry Venables: My first hero >>> QPR’s fairytale of New York

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Andybrat added 19:27 - Dec 14
We should be thankful. Great explanation, I live in Reading, know a lot of fans, wouldn’t mind swapping stadiums. Would make my commute easier
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davman added 21:40 - Dec 14
That point about allowing owners to inject capital is the way to make this work. Spend what you like, but it is YOUR outlay and you cannot attach loss to the club.

Seeing as Scum and City have been bankrolled to get where they are, it is hardly "fair" to stop other clubs following suit. As long as the money for transfers and wages is provided to the club up front and ring fenced, what's the problem?

Of course the real issue is that these owners don't have loose cash; they are general asset rich and cash poor - business is borrow to build in the main. So it's different from "real life", but, guess what football IS different from real life...
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Juzzie added 13:01 - Dec 15
Seems the only people Morris had on strings were the Derby fans who were too blinkered to see otherwise.
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TacticalR added 19:53 - Dec 17
Great stuff Simon. Thanks for going over all the awful details.
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