Decoding Currency Risk: Pictures of Global Risk - Part IV

In my last three posts, I have looked at country risk, starting with measures of that risk and then moving on to valuing and pricing that risk. You may find it strange that I have not mentioned currency risk in any of these posts on country risk, but in this one, I hope to finish this series by looking first at how currency choices affect value and then at the dynamics of currency risk.  

Currency Consistency

A fundamental tenet in valuation is that you have to match the currency in which you estimate your cash flows with the currency that you estimate the discount rate that you use to discount those cash flows. Stripped down to basics, the only reason that the currency in which you choose to do your analysis matters is that different currencies have different expected inflation rates embedded in them. Those differences in expected inflation affect both our estimates of expected cash flows and discount rates. When working with a high inflation currency, we should therefore expect to see higher discount rates and higher cash flows and with a lower inflation currency, both discount rates and cash flows will be lower. In fact, we could choose to remove inflation entirely out of the process by using real cash flows and a real discount rate. 

Currencies and Discount Rates

There are two ways in which you can incorporate the expected inflation in a currency into the discount rate that you estimate in that currency. The first is through the risk free rate that you use for the currency, since higher expected inflation should result in a higher risk free rate. The second is by converting the discount rate that you estimate in a base currency into a discount rate in an alternate currency, using the differential inflation between the currencies.

a. Risk free rate

A risk free rate is more than just a number that you look up to estimate discount rates. In a functioning market, investors should set the risk free rate in a currency high enough to cover not only expected inflation in that currency but also to earn a sufficient real interest rate to compensate for deferring consumption.
Risk free rate in a currency = Expected inflation in that currency + Real interest rate
The risk free rate should therefore be higher in a high-inflation currency than using that higher rate should bring inflation into your discount rate.

But how do we get risk free rates in different currencies? While most textbooks would suggest using the rate on a government bond, denominated in the currency in question, that presumes that governments are default free and that the government bond rate is a market-determined rate. However, governments are not always default free (even with local currency borrowings) and the rate may not be market-set. In July 2015, I started with the government bond rates in 42 currencies and cleansed them of default risk by subtracting out the sovereign default spreads (based on local currency sovereign ratings) from them to arrive at risk free rates in these currencies, which you can find in the table below:

Risk free rates in July 2015

Note that the default spread is set to zero for all Aaa rated governments, and the government bond rate becomes the risk free rate in the currency. Thus, the risk free rates in US dollars is 2.47% and in Swiss Francs is 0.16%. To compute the risk free rate in $R (Brazilian Reais), I subtract out my estimate of the default spread for Brazil (1.90%, based on its Baa2 rating) from the government bond rate of 12.58% to arrive at a risk free rate of 10.68%. To estimate a cost of equity in nominal $R for an average risk company with all of its operations in Brazil, you would use the 10.68% risk free rate in $R and the equity risk premium of 8.82% that I reported in my last post to arrive at a cost of equity of 19.50% in $R. That number would be higher for above-average risk companies, with a beta operating as your scaling mechanism.

b. Differential inflation

There are two problems with the risk free rate approach. The first is that it not only requires that you be able to find a government bond rate in the currency that you are working with, but also that the rate be a market-determined number. It remains true that in much of the world, government bond rates are either artificially set by governments or actively manipulated to yield unrealistic values. The second is that you are adding equity risk premiums that are computed in dollar-based markets (since the default spreads that they are built upon are from dollar-based bond or CDS markets) to risk free rates in other currencies. You could legitimately argue that the equity risk premium that you add on to a $R risk free rate of 10.68% should be higher than the 8.82% that you added to a US $ riskfree rate of 2.25% in July 2015.

If the differences between currencies lies in the fact that there are different expectations of inflation embedded in them, you should be able to use that differential inflation to adjust discount rates in one currency to another. Thus, if the cost of capital is computed in US dollars and you intend to convert it into a nominal $R cost of capital, you could do so with the following equation:

To illustrate, if you assume that the expected inflation rate in $R is 9.5% and in US $ is 1.5%, you could compute the cost of equity in US$ and then adjust for the differential inflation to arrive at a cost of equity in $R:

Cost of equity for average risk Brazilian company in US $ = 2.25% + 8.66% = 10.91%

The cost of equity of 19.65% that we derive from this approach is higher than the 19.50% that we obtained from the risk free rate approach and is perhaps a better measure of cost of equity in $R.

This approach rests on being able to estimate expected inflation in different currencies, a task that is easier in some than others. For instance, getting an expected inflation rate in US dollars is simple, since you can use the difference between the 10-year T.Bond rate and the TIPs (inflation-indexed) 10-year bond rate as a proxy. In other currencies, it can be more difficult, and you often only have past inflation rates to go with, numbers that are prone to government meddling and imperfect measurement mechanisms. Notwithstanding these problems, I report inflation rates in different countries, using the average inflation rate from 2010-2014 for each country.

I also report the inflation rate in 2014 and the IMF expectations for inflation (though I remain dubious about their quality) for each country.

Currencies and Cash Flows

Following the currency consistency principle is often easier with discount rates, where your inflation assumptions are generally either explicit or easily monitored, than it is with cash flows, where these same assumptions are implicit or borrowed from others. If you add in accounting efforts to adjust for inflation and inconsistencies in dealing with it to the mix, it should come as no surprise that in many valuations, it is not clear what inflation rate is embedded in the cash flows.

a. Inflation in your growth rates

In most valuations, you start with base year accounting numbers on revenues, earnings and cash flows and then attach growth rates to one or more of these numbers to get to expected cash flows in the future. At the risk of stating the obvious, the expected inflation rate embedded in this growth rate has to be the same inflation rate that you are incorporating in your discount rate. This simple proposition is put to the test, though, by the ways in which we estimate these expected growth rates, which is to use history, trust management/analyst projections for the future or base it on fundamentals (how much the company is reinvesting and how well it is reinvesting):

1. Past Growth: With historical growth, where you estimate growth by looking at the past, your biggest exposure to mismatches occur in currencies where inflation rates have shifted significantly over time. For instance, assume that you are valuing your company in Indian rupees in July 2015 and that the average inflation rate in India, which was 8% between 2010 and 2014 is expected to decline to 4% in the future. If you use historical growth rates in earnings, between 2010 and 2014, for an Indian company, you are likely to over value the company because its past growth rate will reflect past inflation (8%) but your discount rates, computed using expected inflation or current risk free rates in rupees, will reflect a much lower inflation rate. 
2. Management/Analyst Forecasts: With management or analyst forecasts, the problem is a different one, since the expected inflation rates that individuals use in their forecasts can vary widely. While there is no reason to believe that your estimate of expected inflation is better than theirs, it is undeniably inconsistent to use management estimates of expected inflation for growth rates and your own or the market's estimates of inflation, when estimating discount rates.
3. Fundamental or Sustainable Growth: I believe that the best way to keep your valuations internally consistent is to tie growth to how much a company is reinvesting and how well it is reinvesting. The measures we use to measure reinvestment and the quality of investment are accounting numbers and inflation mismatches can enter insidiously into valuations. Assume, for instance, that you are estimating reinvestment rates and returns on capital for a Brazilian company, using its Brazilian financial statements. Since Brazilian accounting allows for inflation adjustments to assets, the return on capital that you compute is closer to a real return on capital (with no or low inflation embedded in it) than to a nominal $R return on capital, if inflation accounting works as advertised. In countries like the United States, where assets are not adjusted for inflation, you can argue that the return on capital is a nominal number, but one that reflects past inflation, not expected future inflation.  In either case, the growth rate that you compute from these numbers will be skewed.

b. Expected Exchange Rates

It is common practice, in some valuation practices, to forecast cash flows in a base currency (even if it is not the currency that you plan to use to estimate your discount rate) and then convert into your desired currency, using expected exchange rates. Thus, a Brazilian analyst who wants to value a Brazilian company in US dollars may estimate expected cash flows in nominal $R first and then convert these cash flow into US $, using an $R/US $ exchange rate.  The big estimation question then becomes how best to estimate expected exchange rates and there are three choices. 

1. Use the currency exchange rate: The first one, especially in the absence of futures or forward markets, is to use the current exchange rate to convert all future cash flows. This will result in an erroneous value for a simple reason: it creates an inflation mismatch. If, for instance, the expected inflation rate in $R in 9.5% and in US$ is 1.5%, you will significantly over value your company with this approach, because you have effectively built into a 9.5% inflation rate into your cash flows (by using a constant exchange rate) and a 1.5% inflation rate into your discount rate (since you are estimating it in US dollars).
2. Use futures and forward market exchange rates: This is more defensible but only if you then extract risk free rates from these same futures/forward market prices. (This will require that you assume interest rate parity in exchange rates and derive the interest rate in $R from the $R/US$ forward rate). In addition, in many emerging market currencies, the forward and futures markets tend to be operational only at the short end of the maturity spectrum, i.e., you can get 1-year forward rates but not 10-year rates.
3. Use purchasing power parity: With purchasing power parity, the expected exchange rates are driven by differential inflation in the currencies in question. Thus, if purchasing power parity holds and the inflation rates are 9.5% in $R and 1.5% in US$, the $R will depreciate roughly 8% every year. While I am sure that you can find substantial evidence of deviation from purchasing power parity for short or even extended periods, here is why I continue to stick with it in valuation. By bringing in the differential inflation into both your cash flows and the discount rate, it cancels out its effect and thus makes it less critical that you get the inflation numbers right. Put differently, you can under or over estimate inflation in $R (or US $) and it will have no effect on your value.

Currencies and Value

If you can make it through the minefields to estimate cash flows and discount rates consistently, i.e., have the same expected inflation rate in both inputs, the value of a company or a capital investment should be currency invariant. In other words, if you value Tata Motors in Indian rupees, you should get the same value for the company, if you value it entirely in US dollars. If you don't get the same value, I would argue that the difference comes from one or two sources:

• Inflation inconsistencies: It is stemming from inconsistencies in the way that you have dealt with inflation in different currencies, since a company's value should come from its fundamentals and not from which currency you chose to evaluate it in. 
• Currency views: You have built in a currency view into your company valuation. Thus, if you assume that the $R will strengthen against the US dollar in the next 5 years,  when estimating cash flows, notwithstanding the higher inflation rate, you will find your company to be under valued, when you value it in $R. If that is the case, my suggestion to you would be to just buy currency futures or options, since you are making a bet on the currency, not the company.

The bottom line is that your currency choice should neither make nor break your valuation. A well-run company that takes good investments should stay valuable, whether I value it in US dollars, Euros, Yen or Rubles, just as a badly run or risky company will have a low value, no matter what currency I value it in.

Currency Risk

When working with cash flows in a foreign currency, it is understandable that analysts worry about currency risk, though their measurement of and prescriptions for that risk are often misplaced. First, it is not the fact that exchange rates change over time that creates risk, it is that they change in unexpected ways. Thus, if the Brazilian Reai depreciates over the next five years in line with the expectations, based upon differential inflation, there is no risk, but if it depreciates less or more, that is risk. Second, even allowing for the fact that there is currency risk in investments in foreign markets, it is not clear that analysts should be adjusting value for that risk, especially if exchange rate risk is diversifiable to investors in the companies making these investments. If this is the case, you are best served forecasting expected cash flows (using expected exchange rates) and not adjusting discount rates for additional currency risk. 

It is true that currency and country risk tend to be correlated and that countries with high country risk also tend to have the most volatile currencies. If so, the discount rates will be higher for investments in these countries but that augmentation is attributable to the country risk, not currency risk.

Currency Rules for the Road

It is easy to get entangled in the web of currency effects and lose sight of your quest for value, but here are few rules that I think may help you avoid distractions.

1. Currencies are measurement mechanisms, not value drivers: As I write this post, it is a hot day in New York, with temperatures hitting 95 degrees in fahrenheit. Restating that temperature as 35 degrees celsius may make it seem cooler (it is after all a lower number) but does not alter the reality that I will be sweating the minute that I step out of my office. In the same vein, if I value an Argentine company in a risky business, converting its cash flows from Argentine pesos to US dollars will not make it less risky or less exposed to Argentine country risk.
2. Pick a currency and stick with it: The good news is that if your valuations are currency invariant, all you have to do is pick one currency (preferably one that you are comfortable with) and stick with it through your entire analysis. 
3. Make your inflation assumptions explicit: While this may cost you some time and effort along the way, it is best to be explicit about what inflation you are assuming, especially when you estimate cash flows or exchange rates, to make sure that it matches the inflation assumptions that you may be building into your discount rates,
4. Separate your currency views from your company valuations: It is perfectly reasonable to have views on currency movements in the future but you should separate your currency views from your company valuations. If you do not, it will be impossible for those using your valuations to  determine whether your judgments about valuation are based upon what you think about the company or what you feel about the currency. It is this separation argument that is my rationale for sticking with much maligned purchasing power parity in estimating future exchange rates.
5. You can run, but you cannot hide: If inflation is high and volatile in your local currency, it is easy to see why you may prefer working with a different, more stable currency. It is the reason why so much valuation and investment analysis in Latin America was done in US dollars. The bad news, though, is that while switching to US dollars may help you avoid dealing with inflation in your discount rate, you will have to deal with it in your cash flows (where you will be called upon to forecast exchange rates). 

Papers to read

1. My paper on country risk (July 2015)

Data attachments

1. Risk free rates in different currencies (July 2015)
2. Inflation rates, by country (July 2015)

Posts on Country Risk

1. Groundhog day in Greece, Hijinks in Brazil and Market Chaos in China: Pictures of Global Risk - Part 1
2. Valuing Country Risk: Pictures of Global Risk - Part II
3. Pricing Country Risk: Pictures of Global Risk - Part III
4. Decoding Currency Risk: Pictures of Global Risk - Part IV

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Hull City - What's My Name?

Hull City started the 2014/15 season with much optimism after the previous year’s exploits, when they had comfortably retained their Premier League status and reached the FA Cup final for the first time in their history, only losing 3-2 to Arsenal after extra time in a thrilling match. It was therefore particularly disappointing the way things turned out, as their Europa League adventure ended almost before it had started and, most painfully, they were relegated on the last day of the season.

Manager Steve Bruce pointed to the lack of goals: “Nearly 50% of the games we’ve played, we’ve not managed to score. That’s given us too much to do. It’s a pretty damning statistic.” Indeed it is, but in fairness Hull were badly affected by an appalling run of injuries, as they lost Robert Snodgrass in the opening league game and Nikica Jelavic and Mohamed Diamé for long periods.

Nor were they helped by some off-pitch issues with midfielder Jake Livermore testing positive for cocaine and the temperamental Hatem Ben Arfa unexpectedly doing a runner in December.

Steve Bruce has admitted that relegation took him by surprise: “When the transfer window closed at the end of August, I looked at our squad and was quite happy.” Little wonder, as owner Assem Allam had sanctioned a huge outlay on the transfer budget.

In the summer, Hull purchased Abel Hernandez, Snodgrass, Diamé, Livermore, Michael Dawson, Andy Robertson and Harry Maguire, while also  recruiting Ben Arfa and Gaston Ramirez on loan. They later brought the total spend to more than £40 million when they also bought Dame N’Doye in the January transfer window.

This continued the trend of big spending following promotion in 2013. In fact, Hull have splashed a hefty £66 million in the last two seasons with a net spend of a cool £50 million. That works out to an average gross spend of £33 million in the last two seasons, which is a massive increase over the £5 million average in the previous seven seasons. Over the same periods, Hull’s average spend on a net basis has shot up from £3 million to £25 million.

It may be a surprise to some, but Hull’s total net spend of £50 million for the last two seasons was actually the 8th highest in the Premier League. They were obviously still behind the usual suspects (Manchester United, Manchester City, Arsenal, Chelsea and Liverpool), but around the same level as Crystal Palace and West Ham who both outperformed the Tigers.

Given the substantial investment in the team, Hull really should not have struggled so badly last season. The experienced Michael Dawson summed it up best: “The players that the owners and manager have brought in – they spent a lot of money – and we haven’t performed. We should have done better and should be in the Premier League.”

Maybe they were distracted by all the shenanigans over Allam’s campaign to rebrand the club as Hull Tigers, which has caused widespread anger among City fans. The owner’s belief is that a name change would mean that Hull would be better known globally, allowing the club to better tap into Far Eastern markets. Commercial revenue growth is an understandable objective, but it is by no means guaranteed that simply changing the name would result in additional riches. In any case, the Football Association has recently rejected Allam’s application to change the name for a second time.

"There ain't nothing like a Dame"

Furthermore, the way that the owner has justified the change has been a PR disaster, describing the Hull City name as “irrelevant, common and a lousy identity”. Fans that opposed his “textbook marketing” idea of shortening the name were labeled “hooligans and a militant minority”. As if that weren’t enough, he then suggested that those fans "can die as soon as they want, as long as they leave the club for the majority who just want to watch good football.”

That’s a wonderful way to alienate the fan base, which is a great shame, as the owner, who has lived in Hull for over 40 years since arriving from Egypt, has done a lot of good things for Hull City since acquiring the club in December 2010.

The previous regime had brought the club to the brink of insolvency with the auditors stating that there was “significant doubt over the company’s ability to continue as a going concern.” Allam effectively saved the club by staving off a winding-up petition and repaying the debts that Hull had built up under property investor Russell Bartlett. He has since been true to his word to invest in the club by providing substantial funding of around £70 million and bringing a degree of financial stability.

This is reflected in the 2013/14 accounts, the most recent figures published, which show that Hull converted a £25.6 million loss the previous season to a £9.4 million profit, representing a £35 million improvement following promotion to the Premier League.

Revenue grew by £67.5 million (around 400%) from £17.0 million to £84.5 million, largely thanks to the much higher television deal in the top flight, which contributed £60 million of the increase. Match day was also up £6.1 million, including £3.9 million from the FA Cup run, while commercial income was £1.4 million higher. However, the higher costs of competing in the Premier League saw wages rise by £17.4 million (67%) to £43.3 million, while player amortisation was £7.6 million higher.

There was also a £6.3 million provision made against amounts due from the group company Superstadium Management Company Limited (SMC), which operates the stadium and holds the leasehold of the stadium, as granted by the local council.

"I see you, baby, Robert Snodgrass"

As a technical aside, Hull City also show parachute payments under Exceptional Items, but I have included these in revenue to be consistent with other football clubs.

It should also be noted that Hull shortened their reporting period to 11 months by moving the accounting close to 30 June to be in line with the football season. This meant that the 2013/14 figures excluded July’s costs of £6.1 million, so the profit would have been reduced to £3.3. million for the full 12 months.

In addition, the club’s sister company, SMC, reported losses of £5 million, including write-offs to the stadium mortgage inherited from the previous ownership. As Ehab Allam, Assem’s son and fellow director, said, “It’s obviously very disappointing to be almost four years into the ownership and still paying off the debts of the previous regime. We would have wanted to reinvest those sums back into the squad.”

Therefore, the combined loss for Hull City Tigers Limited and SMC would be £1.7 million, but this still represents huge progress considering the 2012/13 accounts showed a loss of nearly £26 million.

That said, most Premier League clubs posted profits in 2013/14, thanks to the increase in TV money allied with the financial fair play regulations that restricted wages growth, so Hull’s £9 million surplus is not really that special an achievement. In fact, only five of the 20 clubs reported losses, a major improvement on previous seasons.

It is also true that clubs promoted to the Premier League always receive a significant boost to their finances. In this way, the other teams promoted with Hull, namely Crystal Palace and Cardiff City, also improved their bottom line by £21 million and £18 million respectively. Cardiff still made a loss in the top flight, but that was largely due to their decision to book £12 million of impairment charges.

After buying the club, the Allams predicted “future trading profitability”, but they had to absorb £55 million of losses before reaching the Premier League: £20 million in 2010/11, £9 million in 2011/12 and £26 million in 2012/13. In fairness, most clubs lose money in the Championship and Hull were no exception.

The chunky loss in 2012/13 was part of deliberate strategy: “The directors made the ambitious decision to go for promotion and to this end invested heavily in the club.” This objective was achieved, which actually increased the loss, as it resulted in bonuses being paid out to the players, management and staff.

Even though Hull’s accounts back in 2008 described profit/loss resulting from player sales as “a significant figure in our accounts”, that is not really the case with a meagre profit of just £1.2 million being made in the last nine years, partly due to the £8.3 million loss reported in 2011.

While Hull only made £1.7 million from player sales in 2013/14, other clubs generated sizeable profits from this activity: Tottenham £104 million (largely Gareth Bale to Real Madrid), Chelsea £65 million (David Luiz to PSG), Southampton £32 million (Adam Lallana to Liverpool) and Everton £28 million (Marouane Fellaini to Manchester United).

Hull’s profit from player sales will be boosted in 2014/15 by the sales of Shane Long to Southampton and George Boyd to Burnley, though many out-of-contract players have simply been released for no fee.

The recent big spending in the transfer market has been reflected in Hull’s P&L account via player amortisation, which surged from £2 million to £10 million in 2013/14, much in the same way that it increased the last time Hull were in the top flight.

However, this is still one of the smallest in the Premier League, only ahead of Crystal Palace £6 million and WBA £5 million, though it will surely rise again in the 2014/15 accounts. As a rule, low amortisation is normally the result of low spending on player recruitment, while those clubs that are regarded as big spenders logically have the highest amortisation charges, e.g. Manchester City £76 million, Chelsea £72 million and Manchester United £55 million.

To clarify this point, transfer fees are not fully expensed in the year a player is purchased, with the cost being written-off evenly over the length of the player’s contract – even if the entire fee is paid upfront. As an example, Robert Snodgrass was reportedly bought for £6 million on a three-year deal, so the annual amortisation in the accounts for him is £2 million.

As a result of these accounting complications, clubs often look at EBITDA (Earnings Before Interest, Depreciation and Amortisation) for a better idea of underlying profitability. Hull themselves have described EBITDA as “a relevant measure, as it is a closer approximation to cash generation than straightforward profit and loss.” On that basis, Hull’s EBITDA has invariably been negative, though it improved considerably in 2013/14 from minus £21 million to £27 million.

That’s not too bad at all, leaving them sandwiched between Newcastle United £27 million and Everton £25 million. Most Premier League clubs are in a fairly narrow range of £20-30 million EBITDA, though the big boys are in a class of their own: Manchester United (an incredible) £130 million, Manchester City £75 million, Arsenal £632 million, Liverpool £53 million and Chelsea £51 million.

Hull’s revenue is largely a story of whether they are playing in the Championship or the Premier League with promotions in 2009 and 2014 increasing revenue by £40 million and £67 million respectively. The larger increase in 2014 is due to the higher centrally negotiated Premier League TV deal.

Hull’s revenue reduced each year in the Championship following relegation in 2011 from £27 million to £24 million then £17 million, purely because the parachute payments from the Premier League fell from £16 million to £13 million then £6 million.

After the 2013/14 accounts were published, Ehab Allam spoke about his plans to expand Hull’s income, “We’re not where we want to be, but we’re heading in the right direction.” Not any more, as relegation will take a large bite out of these numbers.

Despite the sharp revenue growth in 2013/14, Hull’s £84 million was actually the second lowest in the Premier League, only ahead of Cardiff City £83 million. As Ehab Allam said, “The key is where our income is compared to our competitors. We can’t be complacent, because, as we stand, a lot of our rivals have an advantage over us. This club needs a long-term sustainability and we can’t do that by having the income of a side in the bottom three.”

Like every other Premier League club, Hull were in the top 40 revenue earners worldwide, according to the Deloitte Money League, which sounds very impressive, if it were not for the fact that this does not help at all domestically. For example, five English clubs earn more than £250 million a season with Manchester United leading the way at £433 million – or more than five times as much as Hull. This really highlights the magnitude of the challenge for the smaller clubs in the Premier League.

An incredible 81% of Hull’s revenue in the Premier League came from television with just 14% from match day and 5% from commercial income. This was very different to the more balanced revenue mix in the Championship: broadcasting 48%, match day 34% and commercial 18%.

As Ehab Allam explained, “If you look at our income beyond the Premier League money, I still don’t think we’re too clever. The other income we get, commercial activity, gate receipts, is probably less than most clubs in the division.”

Amazingly two Premier League clubs had an even higher reliance on TV money than Hull with  Crystal Palace and Swansea City both earning around 82% of their revenue from broadcasting, but this dependency is clearly not healthy.

Hull’s share of the Premier League television money was £67 million in 2013/14. Most of the money is allocated equally, which means each club receives 50% of the domestic rights (£21.6 million in 2013/14), 100% of the overseas rights (£26.3 million) and 100% of the commercial revenue (£4.3 million). However, merit payments (25% of domestic rights) are worth £1.2 million per place in the league and facility fees (25% of domestic rights) depend on how many times each club is broadcast live.

As a result, Hull’s merit payment for finishing 16th was worth £6.2 million, while the Tigers’ distributions were also restricted by being broadcast live just 9 times, though they were actually paid on the basis of 10 times, which is the contractual minimum. This meant that they only got £8.6 million, compared to, say, Aston Villa’s £13.1 million for being shown live 16 times.

The sensational Premier League TV money is something of a double-edged sword. On the one hand, the £62 million that Cardiff received for being relegated was a lot higher than some major clubs received for winning their respective leagues, e.g. Bayern Munich (£30 million), Atletico Madrid (£34 million) and Paris Saint-Germain (£36 million). On the other hand, as Ehab Allam pointed out, “It might be £67 million we’re getting, but if every club gets that, how do you become competitive? Everything is relative.”

Of course, in 2015/16 Hull will receive a lot less TV money in the Championship, amounting to around £28 million. This will comprise a parachute payment of £25 million and a Football League distribution of £1.7 million plus some money for cup runs, live matches, etc. That will mean a painful reduction in TV money of £40 million year-on-year.

That might sound horrific, but most clubs in the second tier receive just £4 million from television, regardless of where they finish in the league, comprising the £1.7 million from the Football League pool and a £2.3 million solidarity payment from the Premier League. Note: clubs receiving parachute payments do not also receive solidarity payments.

Parachute payments are currently worth £65 million over four seasons (£25 million in year 1; £20 million in year 2; and £10 million in each of years 3 and 4) and have a big influence on a club’s finances in the Championship.

Clearly, being in the Championship will have a major adverse impact on Hull’s revenue. On top of the estimated £40 million fall in broadcasting, there will also be reductions in match day and commercial. I would expect match day to fall back by £4-5 million, assuming no lengthy cup runs and lower average attendances; while commercial income is likely to drop by £1-2 million to 2012/13 levels, depending on whether sponsorship deals have relegation clauses.

That would produce a total reduction in revenue of £46 million from £84 million to £38 million, though this is still likely to be one of the highest in the Championship next season. To place this into context, in the Championship in 2013/14 QPR boasted the highest revenue with £39 million, followed by Reading £38 million and Wigan Athletic £37 million.

There is also the opportunity cost of relegation, as there will be even more money available in the Premier League when the next three-year cycle starts in 2016/17 with the recently signed extraordinary UK deals with Sky and BT producing a further 70% uplift. My estimate is that a club that finishes 16th in the distribution table (as Hull did in 2013/14) would receive around £101 million a season, which would represent an increase of £34 million.

Match day income rose £6.1 million (104%) from £5.8 million to £11.9 million, but this is a little misleading, as it includes £3.9 million from the historic run to the FA Cup Final. Without this “bonus”, Hull’s match day revenue would have been around £8 million, which would have been one of the lowest in the Premier League.

Attendances have been higher in the top flight (around the 24,000 level) compared to the Championship, though this is still lower than almost every other Premier League club, only ahead of Swansea City in 2013/14.

This is partly due to the 25,500 capacity of the KC Stadium, but plans to expand this to above 30,000 were abandoned after the council refused to sell the stadium freehold to the club. Allam understandably protested that “nobody would build an extension on a house if they didn’t own it”, but in fairness to the council they had built the ground with £43.5 million of public money.

This was part of the justification used for the 30% increase in ticket prices for the 2014/15 season: “Due to stadium capacity, our home attendances are the second lowest in the Premier League and with no plans to increase the capacity of the KC, a price rise is the only viable option in terms of increasing revenue from ticketing.” There will be a further price rise of 6% in 2015/16, which seems a bit steep following relegation to the Championship.

Commercial revenue rose £1.4 million (48%) to £4.5 million, but this was still the lowest in the Premier League, behind Crystal Palace £6.9 million and Swansea City £8.3 million. It is easy to see why Allam is so keen on growing this revenue stream. Maybe it’s not a fair comparison, but the big boys are in another league commercially with Manchester United leading the way with a seriously impressive £189 million.

The club recently announced Flamingo Land, a North Yorkshire based resort, as the new shirt sponsor for the 2015/16 season, replacing 12BET, whose deal had been described by the club as the most lucrative in its history. The two-year agreement was originally intended to run until the end of the 2015/16 season, but there was presumably a relegation escape clause. There was also a new kit supplier with Umbro replacing Adidas in the 2014/15 season in a four-year partnership.

Hull’s wage bill rose £17 million (67%) from £26 million to £43 million, but the revenue growth meant that the wages to turnover ratio significantly improved from a typical 153% in the Championship (no doubt inflated by promotion bonus payments) to 51% in the Premier League. As well as higher salaries in the top tier, there was an increase of 35 in the number of players and coaches in 2014.

Despite this growth, Hull’s wage bill of £43 million was still the lowest in the Premier League in 2013/14, behind Crystal Palace £46 million, Norwich City £50 million and Cardiff City £53 million. There then comes a whole bunch of clubs in the £60-70 million range before we get to the elite clubs.

There is a strong correlation between wage bill and sporting success, so it is perhaps not a surprise that Hull have struggled, though it is likely that their wage bill will have been higher in 2014/15 following the major recruitment last summer (though bonuses for staying up will be lower).

Similarly, Hull’s wages to turnover ratio of 51% is also one of the lowest/best in the Premier League, about the same as one of the other clubs promoted in 2013, Crystal Palace. However, the other club promoted that season, Cardiff City, had a much worse ratio of 64% and went straight back down, so spending is not always a guarantee of success.

The Allams are paid via management charges from their company Allamhouse Limited. Although these charges went up from £112,000 to £165,000 in 2013/14, this is still a relatively low sum compared to many other clubs.

The wage bill will be substantially lower in the Championship due to relegation clauses, as outlined by Steve Bruce: “Everybody concerned takes a huge reduction in salary. The club has had a really stringent policy, so that if we do get relegated, it does not fall into drastic times which a lot of clubs do. Most players take a 40-50% reduction in their salary.” Of course, the quid pro quo is that these players also have a reasonable buy-out clause in their contracts, so it is easier for them to leave.

Net debt was cut by £7.4 million from £72.2 million to £64.8 million, as gross debt was reduced by £5.6 million from £72.9 million to £67.3 million, while cash balances rose £1.8 million from £0.7 million to £2.5 million. The debt is entirely owed to Allam’s company with no external bank loans or overdrafts outstanding. The club’s financial problems required an immediate £41 million loan from the owners in 2010/11 and the debt to the owner has risen by £26 million since then.

In addition, Hull owe £13.5 million of transfer fees to other clubs and have £3.4 million of contingent liabilities to players depending on number of appearances and results.

Hull are mid-table in terms of debt in the Premier League, but this has almost certainly increased in the 2014/15 season with the club noting that “new signings costing in excess of £47 million have been made” after the accounts closed. Some have speculated that the debt could be as high as £100 million now, but this will only be revealed once the 2014/15 accounts are published. As long as Allam is happy, this should not be a problem, but it is a worrying amount of debt to take into the Championship.

Unlike many other football club owners, Allam charges around 5% on his loans, which has amounted to around £3 million interest paid in each of the last two years. This is by no means the highest in the Premier League, as Manchester United pay £27 million following the Glazers’ leveraged buy-out and Arsenal pay £13 million for the Emirates Stadium financing, but it is a relatively large burden for a club of Hull’s size.

The cash flow statement highlights the changes in Hull’s approach and the issues that the club now faces after relegation. As a rule, Hull have negative cash flow from operating activities – unless they are in the Premier League. These shortfalls plus any expenditure on player purchases have been covered by loans from the Allams, which got as high as £72 million in 2013.

This is not a problem, so long as Allam does not turn the taps off. When asked about this possibility, his answer was interesting, “It is a lot of money I have put in. So far I am comfortable with it, as long as we are achieving results.” Relegation must therefore be a cause for concern, as that is by definition not achieving results.

It is also a little strange that the Allams were so quick to reduce their commitment once the money started to flow from the Premier League. Ehab noted, “Whatever we’ve made has been put back into the squad. As you can see, we’re not here to make money for ourselves.” That may well be true, but their debt was reduced by £4.7 million in 2013/14.

Just to add to Hull’s challenges, they have been fined €200,000 by UEFA for not being compliant with Financial Fair Play (FFP) regulations. They will have to pay an additional €400,000 if their accounts are not in order for the 2015/16 season. In fairness, this is harsh on Hull, as they were only investigated after qualifying for the Europa League and had little chance to compensate for the large losses in the Championship.

"The drugs don't work"

One minor success story is the academy, which has achieved the appropriate standard to be awarded Category Two status, but even this is not without controversy, as this was helped by building an indoor 3G pitch in the Airco Arena for the academy’s exclusive use, which meant that a number of community sports groups that had been using the facility were told to leave.

The big question now is whether Allam will still want to continue as chairman and owner. From a purely financial perspective, this will be increasingly difficult, as the man himself outlined: “I cannot keep throwing money into it. There must be a limit. Our target is for the club to be self-finance, relying on its own resources.” This will be easier said than done in the Championship.

He may well also walk away now that the FA has again blocked his proposal for a name change. He actually did put the club up for sale in April 2014 the first time that his request was denied, but has not found the right investor yet: “not the quality buyers I would sell to.” Of course, after relegation the club is a less attractive prospect, so the price would have to come down accordingly.

"Ground Control to Major Tom"

In many ways, Allam is a good owner for Hull City, as he explained: “I am a Yorkshireman, I came here more than 40 years ago, yet they still call me a foreign owner. I have never used the football club to make money for myself, I don’t need it. If you go to the stadium, there is not a single mention of me or my company. I saved this club from administration, because I believe that was the best thing I could do for this city. Football is vital to the community. I wanted to give something back. Businessmen should look after their community.”

If only he could resist the temptation to change the club’s name and avoid putting his foot in his mouth when engaging with the fans, he would almost be the perfect owner. He’s a mixture of good and bad, but nothing is ever completely black and white (or should that be amber?) in the world of football.

In the meantime, Allam has effectively paid nearly £70 million for the club to stand still. His son Ehab admitted, “We’re financially strong as long as you make the assumption we stay in the Premier League”, and that has obviously not happened.

"Don't bring me down, Bruce"

Steve Bruce said that the objective was “to compete at the top end of the Championship and bounce straight back into the top flight”, but this will be a severe challenge in one of the most competitive leagues around.

He has already lost a number of key squad players, including Stephen Quinn, Tom Ince, Paul McShane, Liam Rosenior, Maynor Figueroa, Steve Harper and Yannick Sagbo, while others are surely in the departure lounge, including Nikica Jelavic, Dame N’Doye, Mo Diamé and Robbie Brady.

Bruce will certainly need to recruit to have any chance of promotion. Either way, it is difficult to disagree with Michael Dawson’s view that “it is going to be a slog in the Championship.”

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West Bromwich Albion - Like Clockwork

As West Bromwich Albion prepare for their sixth consecutive season in the Premier League, it’s fair to say that they have managed to have rid themselves of the unwanted tag of being a “yo-yo” club that constantly bounces between the Championship and the top flight.

However, the fight to retain their Premier League status has not been without problems in the last two years. They narrowly avoided relegation in 2013/14 when they finished in 17th place, while Albion looked in some danger last season before the Tony Pulis effect kicked in with the results under the experienced manager enough to guide the team to mid-table security. Chairman Jeremy Peace said that this was “testament to the relentless intensity that (Pulis) brings to the challenge” and the team’s improvement fully justified his decision to bring in the Welshman in January.

This coaching change was nothing new for West Brom, who have got through a fair number of managers in their determination to stay in the lucrative Premier League. Since Roy Hodgson left West Brom for the England job three years ago, they have employed no fewer than five managers. First up was Steve Clarke, who guided the club to its highest ever Premier League position of 8th in 2012/13, before a lengthy run of poor results ended in his sacking.

He was replaced by Keith Downing, temporarily elevated from his coaching role, before the former Betis coach Pepe Mel took charge until the end of the 2013/14 season. It was then the turn of Alan Irvine, who was shown the door after a worrying run of only four wins in 19 league games left the club perilously close to the relegation zone, only for Pulis to come in and work his particular brand of magic.

"All the things he Saido"

Throughout this period of managerial upheaval, West Brom have maintained their “steady as she goes” approach, refusing to gamble on the club’s future, resulting in a financial record that is the envy of many. As Peace explained, “We strive to deliver Premier League football whilst growing the club within our means.”

This conservative approach was echoed by chief executive Mark Jenkins, “The club has continued to invest in its playing squad, both in transfer fees and wages. However, with careful budgeting and tight financial controls, we have managed to match our revenue to our costs.” Granted, this might not be the most thrilling of manifestos, but it has clearly worked to date.

While some fans would clearly like the club to spend more on players, that is no guarantee of success. Indeed, they only have to look at Birmingham City, another West Midlands club, to underline this fact, as the Blues were overly reckless and ended up in deep trouble.

In contrast, West Brom have been a model of stability with Peace describing them as “a sound company – an extremely solid football club with no debt, significant assets, a developing infrastructure and reasons to be confident about the future.” That’s a pretty strong sales pitch, which is possibly no coincidence, as the club has effectively been in the shop window for the last few months.

"James Morrison - light my fire"

Peace admitted that the board was “considering strategic options for the future development and legacy of the club”, leading to a number of potential investors from China, America and the Far East expressing interest in acquiring West Brom. This month the chairman confirmed that exclusivity had been granted to one interested party.

The purchase price is believed to be around £150 million, which might sound a little steep for a mid-table club, but it is obviously linked to the riches available to those competing in the Premier League from the new broadcasting deal. This would represent a significant gain for Peace, who holds an 88% share of the club through his company West Bromwich Albion Holdings Limited, and has been in charge at The Hawthorns since 2002.

Although the prospective buyers are now conducting due diligence, Peace says that he does not want this to be a long-running saga that might become a major distraction to the club’s preparations for next season. If a deal cannot be concluded early in the summer, then any takeover would be put on hold for at least another season.

One of the main reasons that West Brom might be attractive to an investor is its strong financial record. Unlike many football clubs, they have been consistently profitable and have virtually no debt. The latest published accounts from the 2013/14 season once again confirmed their ability to make money, as profit before tax more than doubled from £6.0 million to £12.8 million (£10.8 million after tax).

The near £7 million improvement in profit was largely due to the £17 million (24%) revenue growth to a record £87 million, almost entirely from the new Premier League three-year TV deal that started in the 2013/14 season. However, this was offset by higher costs with wages surging £11 million (21%) to £65 million, player amortisation up £2 million (80%) and other expenses rising £3 million (33%).

The figures were then boosted by a £7 million increase in the profit made from player sales to £10 million, mainly from the transfers of Shane Long to Hull City and Peter Odemwingie to Cardiff City.

In most years West Brom’s £12.8 million would have been one of the highest profits in the Premier League, but the times they are a-changing in England’s top flight, as a combination of higher TV money and the financial fair play rules that restrict wage growth meant that no fewer than 15 clubs reported profits in 2013/14.

West Brom had the 8th highest profit in the Premier League, which is still to be commended, especially as the profits of five of the seven clubs above them were significantly influenced by player sales. While West Brom’s £10 million from this activity was not too shabby, it was still lower than Tottenham £104 million, Chelsea £65 million, Southampton £32 million, Everton £28 million and Newcastle United £14 million.

Most of these profits came from one major sale, e.g. Gareth Bale from Tottenham to Real Madrid, David Luiz from Chelsea to Paris Saint-Germain, Adam Lallana to Liverpool and Marouane Fellaini from Everton to Manchester United, but West Brom’s profits come from a more predictable model.

Variety may be the spice of life, but consistency pays the bills, as can be seen by West Brom’s admirable performance off the pitch, where they have reported profits in eight of the last 10 years. This is a great achievement, especially as three of those years were spent in the Championship, where almost all teams lose money as they strive to reach the Premier League.

West Brom’s aggregate profit of £38 million over the last four seasons is actually the 5th highest in the Premier League and about the same as mighty Manchester United £39 million. This is only surpassed by Tottenham £77 million, Arsenal £63 million and Newcastle United £63 million.

In terms of consistency, West Brom are one of only three clubs that have reported profits in each of those four seasons, which is a seriously impressive accomplishment in the highly competitive Premier League. The only other clubs to achieve this feat are Arsenal, the poster child for financial responsibility, and Newcastle United, largely thanks to Mike Ashley’s lack of investment.

In fact, the only occasions that West Brom have recorded a loss in the past decade, 2006 and 2009, were driven by aggressive use of impairment accounting for player values, which increased costs by £9.4 million in 2006 and £17.8 million in 2009. If these items were excluded, West Brom would have also reported profits in both of those years.

On the other hand, their results have been helped in other years by booking reversals on past impairment losses on player registrations, notably £3.0 million in 2007. Similarly, the large £18.9 million profit in 2011 was boosted by the waiver of £7.6 million of inter-company debt with West Bromwich Albion Heritage Limited as part of the group reorganisation.

To better understand the reasons for the player impairment, we need to explore how football clubs account for player purchases. Importantly, transfer fees are not fully expensed in the year a player is purchased. Instead, the cost is written-off evenly over the length of the player’s contract via player amortisation – even if the entire fee is paid upfront.

As an example, if a player was bought from for £10 million on a four-year deal, the annual amortisation in the accounts for him would be £2.5 million. After two years, the cumulative amortisation would be £5 million, leaving a value of £5 million in the accounts. However, if the directors were to assess the player’s achievable sales value as £3 million, then they would book an impairment charge of £2 million. Impairment could thus be considered as accelerated player amortisation.

As we have seen, while West Brom may be considered a selling club, they do not really make big money from this activity, though it is undoubtedly a useful revenue stream. The only double digit profit from player sales in the past few years was the £18 million received in 2008, mainly for the transfers of Diomansy Kamara, Jason Koumas and Nathan Ellington.

Player amortisation has been falling from the £17 million peak in 2006, though this has obviously been impacted by the impairment provisions. Although it rebounded to £5 million in 2014, this is still the lowest in the Premier League.

The only other clubs with annual amortisation below £10 million were Crystal Palace £5.7 million and Hull City £9.9 million, while this is a far more important expense at the big spenders, e.g. Manchester City £76 million, Chelsea £72 million and Manchester United £55 million. This is a reflection of West Brom’s limited spending in the transfer market, though it is likely to have increased in the 2014/15 accounts following the acquisition of the relatively expensive Brown Ideye and Callum McManaman.

With player trading not playing that big a part in West Brom’s model, their profits have largely been down to their underlying business, which can be seen by looking at the club’s EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortisation). Apart from a couple of blips, this has been positive year after year in a steady range of £5-10 million.

That said, although EBITDA improved by £2 million in 2014, West Brom’s £9 million was still the second lowest in the Premier League, only ahead of Fulham £2 million. In fairness, few people would expect them to compete with elite clubs such as Manchester United £130 million and Manchester City £75 million, but this is still a long way below the likes of Norwich City £33 million, Crystal Palace £30 million and Southampton £28 million. This highlights how well West Brom have done in balancing the books when their core business generates so little cash (relatively speaking).

Revenue rose 24% (£17.1 million) from £69.7 million to £86.8 million in 2013/14, almost entirely due to broadcasting, which rocketed 32% (£16.7 million) from £52.6 million to £69.3 million on the back of the new Premier League deal. Commercial income also rose 5% (£0.5 million) to £10.5 million, but gate receipts fell 2% (£0.1 million) to £7.0 million.

In fact, almost all of West Brom’s revenue growth over the last few years is attributable to centrally negotiated rises in the Premier League TV deal. Revenue has increased by an impressive £63 million since 2007, but £60 million of this is from TV money. Commercial income has also risen £4 million, but gate receipts are actually £1 million lower in this period.

Clearly, revenue was much lower in the Championship on account of the far smaller TV deals in the Football League, though this was somewhat cushioned by parachute payments in West Brom’s case. In addition, commercial revenue and gate receipts are also reduced in the second tier.

Despite the healthy growth, West Brom’s revenue is still only the 18th highest in the Premier League, ahead of Hull City £84 million and Cardiff City £83 million. To place this into context, Manchester United’s £433 million is almost exactly five times as much, while there are four other clubs earning more than £250 million: Manchester City £347 million, Chelsea £320 million, Arsenal £299 million and Liverpool £256 million.

Even though every Premier League club is now in the top 40 in the Deloitte Money League, thanks to the amazing TV deal, this does not help domestically when the disparity is so enormous. As Pearce put it, “Every season it is getting tougher competing in the Premier League. You’ve got the huge clubs and the rest of us.”

Unsurprisingly West Brom’s business is dominated by broadcasting, which now contributes 80% of their total revenue, up from 76% the previous season. Commercial is down to 12%, while match day has fallen to just 8%.

Incredibly three Premier League clubs had an even higher reliance on TV money than West Brom with Crystal Palace and Swansea City both earning around 82% of their revenue from broadcasting. Given the importance of the TV money, it is little wonder that Pulis was recruited with his record of never being relegated in his 22 years of management.

Considering the significance of Premier League television money to West Brom, it is worth exploring how this is distributed in some detail. In 2013/14 West Brom’s share rose 36% (£17.5 million) from £48.3 million to £65.8 million. This is based on a fairly equitable distribution methodology with the top club (Liverpool) receiving around £98 million, while the bottom club (Cardiff City) got £62 million.

Most of the money is allocated equally to each club, which means 50% of the domestic rights (£21.6 million in 2013/14), 100% of the overseas rights (£26.3 million) and 100% of the commercial revenue (£4.3 million). However, merit payments (25% of domestic rights) are worth £1.2 million per place in the league table and facility fees (25% of domestic rights) depend on how many times each club is broadcast live.

In this way, West Brom falling from 8th to 17th in the league directly cost them £11.2 million, as their merit payment was only worth £4.9 million, compared to the £16.1 million that 8th placed Southampton received. Thus, the improvement to 13th place in the 2014/15 season will boost West Brom’s Premier League money to £72.9 million, an increase of £7.1 million.

What is also clear is that West Brom’s distributions have been restricted by being broadcast live no more than 10 times, which is the contractual minimum, receiving £8.6 million, compared to, say, Aston Villa’s £13.1 million for being shown live 16 times. This is a hidden way in which the more “glamorous” clubs receive more money.

Of course, there will be even more money available when the next three-year cycle starts in 2016/17 with the recently signed extraordinary UK deals with Sky and BT producing a further 70% uplift. My estimate is that a club that finishes 13th in the distribution table (as West Brom did in 2014/15) would receive around £111 million a season, which would represent an additional £38 million, compared to the current £73 million.

West Brom’s match day revenue of £7 million is the lowest in the Premier League, though four other clubs are also below £10 million: Stoke City £7.7 million, Cardiff City £8.3 million, Swansea City £9.2 million and Crystal Palace £9.3 million. Although not great from the perspective of the bottom line, West Brom have done the decent thing by applying big price reductions in 2012/13 season by a freeze on prices for the next two seasons.

However, as Echo & The Bunnymen once said, nothing lasts forever and the club has recently announced that tickets will rise by up to 14% for the 2015/16 season, though Peace noted that “we remain one of the lowest priced clubs in the top two divisions”, adding that “adult prices for next season will still be 10% lower than a decade ago.” The justification for the increase was competitive pressure: “It is not something the club would have introduced had we not felt it necessary in the quest for West Bromwich Albion to remain as competitive as possible in a league which is relentless in its advances.”

Despite the ticket price reduction and subsequent freeze, attendances have remained fairly flat at around the 25,000 level, albeit higher than the crowds in the Championship. The average of 25,194 in the 2013/14 season was the 16th highest in the Premier League, slightly higher than Fulham.

There had been plans to increase the capacity of The Hawthorns from around 27,000 to 33,000 by redeveloping the West Stand, but these have since been shelved following the lack of improvement in attendances, which Pearce ascribes to the poor economic environment and the increasing number of televised games. Instead, Pearce said, “we will now find ways of adding seats within the existing stadium rather than building new capacity and creating indebtedness within the football club.”

Commercial revenue rose 5% (£0.5 million) to £10.5 million in 2013/14, despite the absence of £0.8 million solidarity money from UEFA that was booked the previous season. Commercial income was up 17% (£1.1 million) to £7.6 million, while merchandising was slightly higher at £2.9 million.

Although this is the fifth lowest in the Premier League, that’s a pretty good performance, only just behind Premier League stalwarts Everton £12.7 million and Fulham £12.3 million. As might be expected, clubs like Manchester United £189 million and Manchester City £166 million are out of sight, but that’s not really a valid comparison.

Similarly, West Brom’s shirt sponsorship is one of the smallest in the top flight. In 2013/14 the shirts sponsor was Zoopla, but they ended their £1.5 million deal at the end of that season, partly in response to the actions of former striker Nicolas Anelka who is alleged to have made a gesture known as the quenelle, which many consider to have anti-Semitic connotations.

As a result, West Brom had to rapidly find a new sponsor with Intuit Quick Books stepping in, albeit at a reduced rate of £1.2 million for the 2014/15 season. Recently the club has announced that their sponsor for the 2015/16 season will be TLC Bet, an Asian betting company, with a better deal approaching £2 million.

No such problems with the kit supplier, as Adidas have recently extended the deal originally signed in 2011/12 to the end of the 2015/16 season, though some supporters were unhappy with last season’s white, pinstripe kit. Even though Pearce claimed that this was West Brom’s best-selling shirt, they will return to the traditional dark blue-and-white stripes next season.

The wage bill shot up 21% (£11.5 million) from £54.0 million to £65.5 million, though the wages to turnover ratio actually improved from 77% to 75% in line with the high revenue growth. Understandably, the wage bill has fluctuated depending on whether West Brom are in the Championship or the Premier League, but wages have been steadily increasing since promotion in 2010, rising by 190% since then. This is pretty much in line with the revenue growth of 209% in the same period, a clear sign of the Board’s desire to “control costs in a prudent manner.”

This sensible approach includes a large performance-related element, as Pearce explained: “You have some appearance money. We have a retention of status bonus if we stay up. They get a certain amount per point. We have flex-downs (up to 50%), so if we get relegated, we have the downside covered on the commitment on the wages.”

Indeed, Albion are one of the few clubs that mention the future wage liability for the remainder of player contracts in their accounts, though it should be noted that this had increased to £94 million following the purchase of players after the end of the 2013/14 season.

Nevertheless, it is still a real challenge for a club of West Brom’s size to pay enough wages to be competitive, as chief executive Mark Jenkins explained, “Of all the Premier League clubs, we commit the highest percentage of our revenue to salaries, the bulk of which is to fund a squad to challenge at the top level.” He is absolutely correct, as West Brom’s wages to turnover ratio of 75% is the highest (worst) in the top tier with only Fulham approaching the same level in 2013/14.

This is not because of an outlandish wage bill, as West Brom’s £65 million is the 12th highest in the Premier League, but that becomes a problem when it is out of line with the revenue, which is only 17th highest. The temptation to spend more on wages is perfectly understandable, given the close correlation with success on the pitch, especially as so many clubs spend between £60-70 million.

In fact, there has been a clear convergence of clubs in this range, as the traditional bigger spenders like West Ham and Aston Villa have only grown a little, while the nouveaux riches like Stoke City, Swansea City, Southampton and indeed West Brom have all had to significantly increase their wage bill in order to compete. The Baggies are likely to further increase their wages in 2014/15 after bringing more players in and paying higher bonuses for the better league finish.

One point worthy of attention is the £1.022 million remuneration given to the highest paid director, who is not named, but presumably is Peace. Although this is lower than the previous season’s £1.341 million, it is still a tidy sum for a business of this size.

West Brom have rarely been big spenders in the transfer market, which has been a source of frustration to some fans, though the brief has been “to ensure our limited resources are invested wisely.” However, this prudent approach has changed recently with a significant increase in spending in the last two seasons. The average annual gross spend has doubled from £8 million between 2006 and 2013 to £16 million between 2013 and 2015, while net spend has risen from a paltry £2 million to £10 million in the same period.

However, everything is relative, Even after this increase, West Brom are no higher than mid-table in terms of net spend in the Premier League, still behind the likes of Crystal Palace, West Ham, Hull City and Aston Villa, as well as the usual suspects (United, City, Arsenal, Chelsea and Liverpool).

As a natural consequence of Albion’s parsimonious approach, their net debt is very low at just £2.1 million, which comprise a bank overdraft secured on the club’s assets of £3.6 million less cash balances of £1.5 million. Following promotion in 2010, debt has been cut from £10 million.

The balance sheet also includes £2.1 million owed to group undertakings, but this is more than covered by £8.5 million owed by group undertakings. In addition, there are contingent liabilities of £2.4 million in respect of player purchases, which are dependent on things like the number of appearances that a player makes.

The reality is that West Brom are effectively debt-free, which is a magnificent achievement for a club of their resources operating in the Premier League, as can be seen by the amount of debt other clubs of their level have built up, e.g. Cardiff City £135 million and Hull City £67 million. It is therefore no great surprise that they appear to have loosened the purse strings a little, especially with the blockbuster Premier League deal on the horizon.

Basically, West Brom operate a self-sustaining model that does not require additional loans or increases in share capital, so you might expect them to be firm proponents of Financial Fair Play (FFP), which essentially forces clubs to live within their means.

However, that is not the case, as Peace explained: “We were not in favour of the introduction of these regulations. Whilst it is our view that all football clubs should be financed in a sustainable manner that is guaranteed, we would prefer to operate in a market free from other regulations. We regard Financial Fair Play as a misnomer. We believe the new rules are anti-competitive and will further reinforce the existing pecking order in the Premier League. No longer will a major investor be able to join a club and change the Premier League landscape.” He added, “The new FFP rules mean that we will, more than ever, have to think outside the box to ensure our limited resources go further.”

"Hong Kong Gardner"

This might mean an increasing focus on youth to produce talent such as the exciting forward Saido Berahino. According to Peace, the club invests £3 million a year in their Academy (net £2.2 million after a subsidy of £800,000) and has been awarded Category One status. New facilities were unveiled in January by Baggies legend Tony ‘Bomber’ Brown.

Then again, this brings its own challenges with Berahino openly talking about hoping to “move on to bigger things.” In much the same way, Albion lost the talented Izzy Brown to Chelsea for nominal compensation, due to the much criticised Elite Player Performance Plan. Even so, there is still optimism about some of the youngsters at the Academy, such as forwards Adil Nabi and Jonathan Leko.

Peace is the first to admit that West Brom have had “a couple of difficult seasons during which we have not made the progress we wanted”, but things have markedly improved since the arrival of Tony Pulis and he will have the whole summer to “address the playing squad more fully and re-shape it into something more akin to his specifications.”

"Is Vic there?"

A change in ownership is something that could complicate this objective, but Peace has said that any new management would commit to “the management model which I believe has served the club so well.” He promised that any transition to new owners “should be smooth and devoid of upheaval.”

Let us hope that he is correct, as there is much to admire in West Brom’s under-stated approach, As Peace said, “We are plugging away, trying to compete in the most high-profile, difficult league in the world, punching way above our weight.” The club deserves a lot of credit for that, while at the same time remaining profitable and debt-free.

A takeover could provide additional impetus to West Brom, though Financial Fair Play regulations mean that a new owner could not operate with complete freedom. In any case, it might be worth remembering the old saying, “the grass isn’t always greener on the other side.”

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