Chelsea’s new transfer strategy – how they have used accounting principles to engineer a transfer bonanza

How the strategy works

Financial fair pay is governed by profitability rather than cashflow. This means that as long as a club breaks even from a profit perspective (or falls within the allowable deficit), it is deemed to be compliant. The expense included in the profit and loss statement in relation to a transfer is the amortisation cost. This is the total transfer fee divided by the contract term agreed with the player. This expense is then incurred on the profit and loss statement each year on a straight-line basis over the duration of the contract. Therefore a club can reduce the P&L impact of a major transaction by spreading it over a longer period.

From a numerical perspective, if a more standard 4-year contract was offered to Enzo Fernandez, the yearly P&L impact for Chelsea would have been (£105m/4 years) £26.25m versus the £13.125m (£105m/8 years) they will actually incur; a substantial saving.

Risks surrounding the strategy

However, there are a number of risks and additional factors to consider:

Long-term commitment to the player

Perhaps the most apparent risk surrounding this strategy is the long-term commitment being made to what are certainly promising, but also unproven players who have yet to adapt to the Premier League. If Mykhailo Mudryk turns out to be the next Nicolas Pepe, then Chelsea will be saddled with paying his substantial salary for the next 8 years with little chance of shifting the player and no incentive for the player himself to agitate for a move. Think Gareth Bale seeing out the final years of his Real Madrid contract on the golf course. Such a salary commitment will weigh on the club for the remainder of the 2020s, taking up valuable profit which could potentially be better utilised on other players.

Profit/loss from a subsequent sale

The value that players are recorded at in the balance-sheet is initially set at the transfer fee. This is then reduced by the amortisation charge each year. This means that if a player is on a 4-year contract, after 3 years their value in the books will be just 1/4 of the initial transfer fee. However, if the player is on an 8-year contract the value in the books would be 5/8 of the transfer fee.

This has a substantial impact. In the example of Enzo Fernandez given earlier, this would mean his book value after 3 years would be £26.25m on a 4-year contract and £65.625m on an 8-year contract. Therefore, as profit on the sale of a player is the transfer fee you receive less the player's book value, it means that if Chelsea did ever want to sell Fernandez in the future, it would be much more challenging to make a substantial profit on him.

Any profit made on player sales contributes to FFP compliance. Because Jorginho was close to the end of his contract, his book value was very low, meaning the £12m he was sold for would almost all have been accounted for as profit, helping Chelsea to remain compliant in the current year. Therefore Chelsea are effectively swapping the benefit of a lower yearly amortisation charge for the potential to make a substantial profit on a player sale in the future.  

Cash vs profit

An important point to make is that cash and profit are not the same. While not ideal, there is scope for a company to be successful and still make a loss. Think Uber, Airbnb and indeed most football clubs. The bigger issue however surrounds cashflow. If a company doesn't have enough cash to settle its creditors, then it can enter administration. In a football context administration means docked points and ultimately expulsion from the league. Bury didn't experience this because of their profit or loss, it was rather because they didn't have the cash to settle a significant tax bill along with other major creditors.

Therefore for all the potential profit savings the Chelsea strategy opens up it still doesn't get away from the fact that the club is using huge amounts of cash to pay the inflated transfer fees to get these new players through the door. It isn't immediately clear how the £500m plus outlay on transfers under the Boehly regime will be reflected in Chelsea's books, however, if debt financing is utilised it will create a liability that the company needs to use cash to settle at some point.

Not growing existing talent

From an accounting/profitability perspective, developing and then selling on a home-grown academy player is an absolute goldmine. There is no transfer fee involved in obtaining these players meaning that when they come to be sold they contribute pure profit – which as we have established is vital for compliance with FFP. This is likely why Chelsea pushed so hard for the potential sale of Connor Gallagher to Everton on deadline day. The 8-year contract strategy will only work when signing young players (as you would not want to continue to pay a player such a wage when they're approaching or even beyond retirement age). Therefore employing such a strategy may reduce the opportunities for Chelsea's own young players to develop and so become the major profit generating assets of the future.

Conclusion

While Todd Boehly's strategy is certainly an innovative attempt to ensure compliance with FFP, it isn't without significant risk. Chelsea are likely trading a short-term spree for long-term financial limitation. However, if both Mudryk and Fernandez end up developing into the world beaters that they have the potential to be then, I'm sure no Chelsea fan will be complaining.