There’s a misunderstanding about FFP and Share Equity requirements in the Championship that keeps cropping up. This essay is my reference about this specific issue so new rules can be better understood.
In the Olden Days
Before June 2016 we had the original FFP rules which worked on a single year’s accounts.
They were pretty easy for everyone to understand.
Part of these rules said that a club could, in any one season, lose up to £5m without failing FFP.
The rule went on to say that if the loss in that single year was more than £5m then the owners had to buy new equity shares in the club to the exact same value as the excess above £5m.
If this equity was bought then there would be no further sanctions.
The caveat was that losses in that year could not be more than £13m. So at the worse case, a club losing £13m had to issue new shares of £8m to comply with FFP and not be sanctioned.
Losses above £13m would mean an automatic transfer embargo.
This simple one-year system was not liked by club owners because it limited their ability to take risks and spread growth over a period of more than one season.
So the EFL scrapped it. Completely tore up those rules and this £8m forced equity purchase every year has gone, consigned to the history books of good intentions .
It died on 30th June 2016 and hasn’t been replaced with anything like an equivalent.
In Our Enlightened Age
As the original FFP rulebook expelled its last breath a new kid on the block emerged.
This new superhero of football club financial sustainability was named P&S Rules or Profit and Sustainability Rules, a new light in the quest for Financial Fair Play.
P&S Rules are more complicated.
Firstly they operate by totalling up the losses for the current season with the losses from the two previous seasons.
If this total is less than £15m then a club will pass FFP P&S tests and no sanctions apply.
However, if the total losses exceed £15m then the owners have to buy equity shares.
Now this might sound like the old method and you might expect that the value of shares the owners have to buy is equal to the loss above the £15m limit.
That would be simple to understand but it doesn’t really help a club’s financial stability.
So the EFL didn’t copy the old method, they created a new way to calculate how much equity shares the owners must buy.
Cashflow Kills Companies not Losses
This is an adage in the business world that is actually true!
A company or football club can continue to operate and trade so long as it has enough cash to pay its debts on time. If it can do so it is solvent.
If it runs out of ready cash in its bank account then it is insolvent and goes into administration or liquidation. This is what the EFL call an “insolvency event”.
So it does make sense that the EFL should call on owners who are reckless or incompetent and run their club at a loss to ensure their club does not run out of cash.
The EFL have chosen to do this by calculating what they call “cash losses”.
Many fans have become familiar with Profit and Loss Sheets in recent years because this P&L Sheet shows the losses that the FFP tests are based around.
However, we now need to look at another sheet in the published accounts, the “cashflow sheet”.
The Cashflow Sheet
This cashflow sheet differs from the P&L sheet in a few ways but the main difference relevant to football fans is the player amortisation.
We have become well aware that for FFP purposes clubs can spread the cost incurred to buy a player over a few years, rather than having the full cost of purchase hit profits in one huge hit.
So the cost of purchase is divided up into equal chunks for each year of the player’s contract. This is for FFP profit or loss calculations.
Many of us know that when we buy a player we don’t pay all the cash in one lump, just like when we buy a car or a house we spread the cash payments over a period of time.
Clubs spread the cash payments over a period of time that is different to the length of a player’s contract. This is part of transfer fee negotiations but is normally two or three years.
So each year a club pays out a few small cash sums for players previously bought and receives a few small cash sums for players previously sold.
Remember that the Profit and Loss Sheet shows the cost split each year.
The cashflow sheet is where the ACTUAL CASH PAYMENTS and RECIEPTS are recorded each year.
So since lack of cash kills clubs and the EFL is trying to stop clubs dying, we need to look at the Cashflow Sheet to see if it is running out of cash.
When we look at a Cashflow Sheet we can see how much cash has left the club each year. We can total up how much cash has left the club over the three years of the accounts we are looking at.
The EFL calls cash leaving the club over this three year period “Cash Losses”.
Equity Amount Demanded From Owners
Now that we’ve calculated the cash losses a club has incurred the EFL demands that owners put all that lost cash back into the club out of their own pockets.
To make sure this cash is not a loan that an owner can pinch back later the payment from owners must be for equity shares.
The value demanded can be any value from zero to many millions of pounds; there is no fixed amount like there was before 2016.
The amount just depends on the actual CASH that a club has lost.
Exception to the Rule
The EFL, in its wisdom, has bowed to pressure from club owners who argue that a club can have a poor three years, and incur cash losses, but could be run differently for the next two years and make cash profits that wipe out these cash losses.
I have a little sympathy with that; clubs may have valuable players they can sell to put cash back into the club or they may have some players that they have sold that season and the cash will come in over next two years.
It is a kop out really but the EFL went along with it. So if owners can show that enough cash is coming to the club in the next two years they can avoid buying equity shares until later.
Postscript for Leeds United
Remember that FFP losses are P&L Losses reduced by taking off allowable expenses.
We do not have published data for the season just finished but we do have for the two seasons before.
If we estimate last season and total them together the FFP losses do not exceed £15m so there is no requirement for Leeds’s owners to put in equity.
However, if there was a requirement, the cash losses would be around £15m for the first two seasons plus whatever the cash losses were last season.
Leeds’s owners have already put in £20m of share equity and so would likely be required to put in only a small amount.
Mike Thornton – 8th August 2019
All the critical references used in this essay, along with a more technical discussion, are given here: