Fear the Financials: An Introduction

Introduction

Hello all, and welcome to the first article of a new series of articles here on FTW, called Fear the Financials. The general goal of this series will be to teach some of the basics of accounting as it applies to football, analyze BVB’s financials, and compare their financial performance to that of other teams.

For a little bit of a background on myself, I’m currently a university student in the US studying accounting. I say that because, I’m definitely not an authority on accounting, let alone football accounting, still being in school and all. And it’s somewhat relevant to mention that I’m in the US, because there’s US standards (GAAP) and European standards (IFRS), but I’ll leave it at that because it’s very boring and not at all relevant to the general scope of this.

Before I get into any analysis, which I plan to do in later articles, I want to sort of lay a foundation of some of the basics of accounting that I feel are important to know, before eventually getting deeper. If you’re familiar with accounting, you’ll probably have an understanding of this already.

The Basics

Accounting operates on an accrual basis, not a cash basis (small businesses do typically operate on a cash basis, but not massive enterprises like Dortmund). Revenues and expenses must be recognized as they’re incurred, not as the cash is received or disbursed. It’s a concept that underlies basically everything in accounting.

Going along with this, expenses have to be “matched” to when revenues occur. This is hugely important as to why transfers are capitalized and then amortized. To simplify it, think about wages. Players are earning the club revenue (matchday, broadcast, commercial, etc.) by playing, and the club compensates the players for that by paying them wages (the period the wages are paid match the period the revenue is earned). That same basic idea applies to amortization, too (a player on a 3-year contract has their transfer fee amortized over that 3-year period).

There’s a few terms that I should define for people who are unfamiliar. I’ve already mentioned “capitalization”, or “capitalized”. It’s really just a fancy way of saying, acquiring an asset and recording it on the balance sheet as an asset (if Dortmund buys new computers for their analytics department that they plan on using for a long time, they’d capitalize it). This is different from “expensed”, where it’s recorded as an expense straightaway, and shows on the income statement (Dortmund paying out wages to staff, player personnel, etc. is an expense).

There’s also the terms amortization and depreciation (they mean the same thing, but amortization is for intangible assets). So when you use an asset over a period of time, the costs have to be “matched” to revenues, and the way this is done is by depreciation, which decreases the value of an asset over time, by expensing it (if Dortmund buys Watzke a new desk, and they plan to use it for 10 years, and they paid $1000 for it, every year they’d record depreciation of $100). So, by way of depreciation/amortization, most capitalized assets are going to be expensed eventually, but it’s just a matter of spreading it out evenly over time rather than all at once.

Transfers and Amortization

Like previously mentioned, when players are purchased for a transfer fee, they’re capitalized, not expensed. When a team purchases a player from another team, they’re really purchasing an intangible asset, and that being the player’s registration rights. For example, when BVB bought Mats Hummels from Bayern for a fee around $30 million (it was actually €38 million but $30 million is an easier number for calculations), that wasn’t an expense of $30 million, they gave Bayern $30 million for an asset.

But the asset still has to be depreciated (or in this case, amortized, since it’s an intangible asset) as it’s used (over its useful life), which is something that goes for pretty much all long-term assets. The useful life is the 3-year contract Hummels signed with BVB at the time of the transfer. We’ll use straight line depreciation, which is the standard for this type of transaction anyway. $30 million divided by 3 years is $10 million per year. So BVB will record an amortization expense of $10 million at the end of every season. When it comes to teams’ financials, a higher amortization expense number will reflect more investment in the squad. A team with $200 million of amortization will have spent a lot more on incoming transfers than a team with $50 million.

It also might be important to keep in mind that amortization expense is separate from his wage expense. The amortization is basically an arbitrary filler number used just for the purpose of amortizing the asset to its salvage value (which, for footballers, is zero); it’s a number that’s completely independent of his wage.

If he extends his contract we’ll have to recalculate the amount of the amortization. So if at the end of year one of his contract, he adds another year, the amortization expense will be recalculated at a value of about $6.67 million (his rights were worth $20 million at the end of year one, and he upped his contract for another year, meaning he still had 3 years remaining, instead of the previous two. $20 million divided by 3 is $6.67 million).

And let’s say in the season after that, BVB decide to sell him. They accept an offer from Arsenal for $25 million, because all BVB players end up there eventually. He’s currently on the books as being worth $13.33 million (The original $30 minus the $10 at the end of year one of his contract, minus the $6.67 in year two). The transaction would be recorded as receiving $25 million cash, taking his $13.33 million off the books since we no longer own his rights (this is “de-capitalized” if you will, not expensed, but Dortmund actually records it as an expense), and recording a gain of $11.67 million on the sale. It goes against the traditional idea, that we paid $30 million and sold him for $25 million so we sold him at a loss, however, for accounting purposes, it’s a gain.

Why any of this matters

This all ties back to the financial statements. Let’s say for example, during the season they acquired Hummels from Bayern for $30 million, before accounting for it, Dortmund had total revenues of $400 million and total expenses of $300 million. By capitalizing the purchase for $30 million and recognizing the amortization expense of $10 million, Dortmund’s expenses would rise to $310 million, rather than $330 million if the transfer was recognized on a cash basis and expensed all at once.

And let’s say in the season Hummels was sold to Arsenal for $25 million, Dortmund again had revenues of $400 million and expenses of $300 million. They’d recognize the gain of $11.67 million on the sale, and Dortmund would have revenues of $411.67 million. A disclaimer here, to make things a bit more complicated, is that Dortmund (as well as some other teams like Hertha Berlin and Juventus, but strangely, not Celtic), in their method of accounting, would recognize the amount of the whole sale as revenue, meaning revenues stand at $425 million, but they would also recognize the write-off of the book value as an expense, so expenses stand at $313.33 million. This brings you to the same net income number of $111.67 million, but revenues and expenses are just listed a little bit differently.

The End

This is definitely a good point to stop. In a few weeks I should release another one of these, but I’ve yet to decide whether I want to expand on this some more, or to try to dive into actual analysis.

Questions and comments more than welcome!