Financial Fair Play – New Tests
The Unspoken Details of Profit and Sustainability Rules
*** NOTE – this essay was written in 2018 and has been updated in July 2019 to make some points clearer and events more up-to-date.
There is a lot of confusion about FFP rules and the punishments now involved. This essay attempts to explain how FFP changed recently when Profit and Sustainability Rules (P&S Rules) were introduced.
This essay also introduces the extra tests, obligations and sanctions that were added to FFP by the Profit and Sustainability Rules (P&S Rules) in 2016. The old FFP rules were scrapped in 2016 and no longer apply.
FFP tests and rules are now very different to the original versions that the likes of Leeds United, QPR, Bournemouth etc have fallen foul of in the past.
The tests are much more complicated than the old, simple rule; “you can lose up to £39m in any three year period”.
There are now THREE TESTS applied to clubs to see if sanctions will be levied.
The penalties are now much more flexible than just “a transfer embargo” and there is no longer any mandatory punishment, such as a transfer embargo.
The EFL can no longer demand owners inject equity to cover adjusted losses above £5m in any year. The EFL now can demand much more complicated funding is supplied by owners.
The change to FFP rules was implemented at the request of club owners who found the old test limitted their ability to buy their club’s way to promotion.
The change was decided in 2015 and started in 2016, a long time before Radrizzani bought into Leeds. He was not involved in requesting or moulding the changes.
All club accounts are adjusted by the EFL to remove any excessive sponsorship or advertising income received from owners or related parties before the Tests are started.
All initial information must be provided by the club to the EFL by 1st March of the current season. Any further information must be provided on demand by the EFL.
The tests mentioned below start to be done by the EFL after 1st March and can continue during the summer, or beyond, depending upon the extra information provided by clubs.
Test 1 – Companies House Accounts
Add together the profits or losses shown on the last two accounts published at Companies House.
No adjustment is made to these accounts except to remove inflated sponsorship etc by owners.
If the total profit/loss from these TWO years shows a loss of any amount, then the Club FAILS Test1.
What happens if you fail Test 1?
A Club that fails Test 1 then moves to a three year analysis and must supply to the EFL the last two years’ published accounts plus an estimate for the current season’s accounts.
These accounts are adjusted to remove any costs due to “allowed spending” such as depreciation of stadium costs, cost of community football, cost of women’s football, cost of youth football, etc.
When the accounts have had these allowable costs removed we call them “Adjusted Accounts” or “Adjusted Earnings”.
The profit or loss shown on Adjusted Accounts is the FFP profit or Loss.
Note – if the club has been profitable over the previous two seasons and passed Test 1 then they do NOT have to submit an estimate for the current season, even if they have made huge losses in the current season. There is however a separate regulation that allows the EFL to request more information if they think a previously profitable club has suddenly started to massively overspend.
When the Adjusted FFP profit or loss has been calculated the next test is applied.
Test 2 – three year LOWER loss threshold
Add together the Adjusted FFP profits and losses for the three years (current season plus two previous seasons).
If this total three-year FFP profit or loss results in a loss of more than £15m then Test 2 (three year LOWER loss threshold) is FAILED.
Note 1 – there is a sub-test where all clubs who have a total 3 year loss of between £0m and £15m must supply a budget for the next season to demonstrate to the EFL that they will be able to fund themselves over the next season and take part in all matches.
Note 2 – the LOWER loss limit is £15m total over three years, do not confuse it with the £39m UPPER loss limit for later tests.
Failing Test 2 Consequences
Clubs who fail Test 2 must then provide extra information to the EFL about their plans for the next two seasons. The clubs must convince the EFL that they:
If a club can convince the EFL that all is well (by providing proof of secure funding along with predicted trading within FFP rules) it can continue next season without EFL interference but those who cannot do so then become subject to EFL restrictions.
Sanctions for failing Test 2
If Test 2 is failed then it is possible for a club to convince the EFL that all is well and their trading over the next two seasons will be within FFP rules and they have the funding to play all matches during the next two seasons.
If they cannot convince the EFL that they can trade within the rules, then the EFL can impose the following sanctions:
I made mention of “Secure Funding” in this list. This Secure Funding requirement replaces the equity injection that owners used to have to do under the old rules.
It does NOT require owners to “make good” the FFP losses or even the losses filed at Companies House. It does require owners to “make good” any “CASH LOSSES” over a FIVE year period – yes, FIVE years, not three years. Cash Losses are the real cash losses incurred by the club and do not have the accountancy adjustments, such as depreciation & forward commitments, etc., included. You may have read some online analysts use the term EBITDA when discussing a club’s financial results; EBITDA is a close approximation to what Cash Losses are and the owner must make good the total EBITDA losses over a five year period.
This change was made by club owners before 2015 and before Radrizzani came to Leeds. There is a saying in accountancy “companies go bust due to lack of cash and not because they made losses”. Many companies can withstand losses for many, many years (look at the company that built the Channel Tunnel) but they go bust as soon as the cash runs out.
Birmingham City failed Test 2 (three year LOWER loss threshold) last year and did not satisfy the EFL they were going to meet these future requirements. They were then placed under EFL sanctions, so called “Soft Sanctions” and “Soft Embargo”. They refused to comply with the terms of the sanctions and points were deducted. Sheffield Wednesday also failed Test 2 and got Soft Sanctions and embargo applied to them; unlike Birmingham, they seemed to have complied with the rules and escaped points deduction.
Leeds United probably did NOT fail Test 2 at the end of last season (that is, at the end of 2018/2019 season) with Adjusted FFP profits/losses of maybe +£4m + £0 – £13m = total 3 year FFP losses of only £9m.
Without taking action this summer to manage FFP losses, Leeds United could well have posted 3 year total FFP losses next summer of £0 – £13m – £23m = FFP Loss of £36m. This is close to the FFP upper threshold of £39m loss where points are deducted; increasing costs by buying new players without first taking other action could have been disastrous. Now that the Club has managed the situation this danger has gone, in my opinion.
Clubs passing Test 2 do not get tested further. Clubs failing Test 2 also get another test applied, Test 3.
Test 3 – three year UPPER loss threshold
This test is done the same way as for Test 2 but the loss limit used for this test is £39m (not £15m as before and see note at end of essay re EPL relegated clubs). This test is similar to the original FFP test and many people still think that this is the only test, however as I have shown, other tests are now in force.
When the profits and losses of the Estimated Adjusted accounts for this season plus the Actual Adjusted accounts for the last two years are added together they must not exceed a £39m loss. If they do then Test 3 (three year UPPER loss threshold) is FAILED.
The consequences of failing Test 3 are set out below.
Failing Test 3 Consequences
There are two parts to the consequences of failing Test 3.
The first consequence is that exactly the same sanctions as failing Test 2 can be imposed. I won’t repeat them – just read the paragraph above “Sanctions for failing Test 2” about agreed budgets and soft embargoes.
The second consequence is more serious: The Club can be held to be in breech of the EFL Rules and referred to the Disciplinary Committee. The Disciplinary Committee has a wide range of sanctions it can impose and these include a warning, a fine, points deduction, transfer embargo, suspension or expulsion from the EFL.
This essay has shown that the current FFP regulations, which now include the EFL Profit and Sustainability Rules, have three tests within them and are very much more complicated than the simple test of the original FFP.
The new rules do not have mandatory penalties and some clubs may already be sanctioned under the new tests.
Soft Sanctions are applied to clubs with FFP losses of more than £15m, up to £39m, but only if they cannot provide proof of secure funding from owners and a two year budget forecast showing the club will be within FFP limits.
Disciplinary action (including possible points deductions) comes from losses of more than £39m or flouting any soft sanctions in force.
The new P&S Rules of FFP are so complicated it becomes impossible for fans to make easy judgments and a lack of transparency by the EFL compounds this complication.
Mike Thornton 1st August 2018, updated 23rd July 2019
NOTE – Limit for Test 3 for EPL clubs
The limit I have given of £39m maximum loss is for clubs who have only been in the Championship.
This is calculated as £13m per EFL season. For clubs relegated from EPL their limit is £35m for each season spent in EPL plus £13m for each season in EFL.