Having spent some time reviewing the finances of my own club, Nottingham Forest (see that analysis here), I decided that it would be interesting to take a look at the other two Championship sides from the East Midlands. In part this is due to the rivalry of between the three clubs but mainly it is because they are in many ways similar sized but they are perceived to have taken different approaches t the way they are run.

Forest have long been owned by lifelong fan Nigel Doughty, although that has just changed, and are often viewed to be well funded but not extravagantly so. Leicester City who have been under the ownership of a Thai consortium for the last couple of years are generally considered to be free spending , possibly even reckless. Meanwhile, Derby County, who I am about to look at here, are often held up as an alternative as although they are owned by an American consortium they appear to have trying to cut costs, focus on youth development and try to be more sustainable since appointing Nigel Clough as manager in January 2009.

My approach as always is to look at the published financial statements for each club but to then adjust them for cash. By this I mean that I remove any non-cash accounting adjustments and report only cash income and expenditure, as I think that this is most relevant and it evens out potential different accounting treatments – such as amortising fees for players over the length of their contracts. Generally cash is king and in this way it is also clear how much each club’s owners have had to plough funds in (or perhaps take out loans) to meet any shortfalls.

Recent History of Derby County

Derby were promoted to the Premier League in 2007 under the management of Billy Davies, but were immediately relegated again the following season. During that season Davies was sacked and replaced by Paul Jewell, who himself lasted little over a year before the club decided to put its faith in the legendary name of Clough, appointing Nigel in January 2009.

The appointment of Clough coincided with a strategic policy to cut the wage bill and develop young players with the intention of cutting out some of the Premier League fat that had developed and taking forward a leaner club that could be sustained in the Championship before re-emerging as a realistic challenger for promotion.

At least that is the perception that I have had as an outside observer and have seen others attribute to Derby in recent seasons. The reality seems to ask some questions as to whether sustainability is even possible in the Championship.

Financial Review 2009/12

In financial terms Derby’s albeit brief trip into the Premier League meant that they were eligible for Parachute Payments in both the 2008/09 and 2009/10 seasons, giving them an inflated turnover and the ability therefore to support an inflated wage bill. Nigel Clough inherited a very large squad when he arrived in January 2009 – during that season (2008/09) the wage bill was £22.1M  and in his first full season in charge (2009/10) he managed to bring that down to £16.4M.

This was now a manageable figure because turnover was high for a Championship club at £29.8M, twice that of rivals Forest and dominated by £16M from television, radio and internet income. This meant that the club made an operating profit in the year, although a net transfer spend and the cost of servicing debts led to an overall cash loss of £(3.4)M.

To overcome the cash deficit the club’s owners injected equity capital of £6.6M which covered the gap and also reduced the balance on their loan debt from £25M to £20M.

This would be the final year of parachute payments, however, and so Clough had been tasked with bringing down the club’s wage bill further in preparation for the drop off in income. In 2010/11 turnover fell to £18.1M, still good for the Championship but substantially down on the prior year, whereas wages only reduced to £13.2M. As a result the club posted an operating loss of £3.9M, even though non staff costs were reduced from £11.9M to £8.8M.

After transfer spending, debt servicing and some investment in fixed assets the final cash loss for the year was £6.4M and with no injection of capital from the owners the club’s loan debt rose sharply to £27.2M.

It was a similar story in 2011/12 with revenues holding up reasonably well at £17.3M but the club unable to reduce its wage bill further with staff costs stuck at £13.0M. Operating losses rose to £4.9M and final cash losses after another net transfer spend and further debt servicing costs reached £7.7M.

So despite efforts to re-structure the wage bill – now half the level it had been in the Premier League in 2007/08 – and the consequent impact this had on league placings the club remains substantially loss making as a result of lost parachute payments and with the owners not putting in their own money again the club’s loan rose to £34.2M by June 2012. (The loan is made up of 4 elements £18.5M owed to its parent company, £0.1M secured against future income flows, £15.1M secured bank loan and £0.5M preference shares).

For me this highlights the difficulty of trying to run a Championship club in a financially sustainable manner, especially when the team is on a downward trajectory rather than rising through the leagues. Clubs such as Swansea and Blackpool have managed to compete effectively with lower cost bases because of their upward curve which meant they started with a lower cost base and lower expectations in terms of transfer targets and wages offered.

The likes of Derby, and their local rivals Forest, have high expectations and try to target more established players to appease fans. There is a sense that as “big” clubs they should be paying more and showing more “ambition” but this often results in poor value and increased frustration.

Ironically under Financial Fair Play the size of losses that Derby are making are not an immediate concern but they do rely on either a high and growing level of debt or for regular cash bailouts from owners. Even a radical overhaul of the wage structure from its new lower level would not wholly solve the problem as other costs are also high.

The problem for bigger Championship clubs is that the cost of player development has risen with the expectations of academies in the modern game and so has the cost of looking after your first team as ambitious Championship players expect to be treated well, whether it be the best training facilities, medical care and so on.

The gap in income between the second tier and the top is too large to sustain the expectations of players and fans when you are playing in the Championship but want to be taken seriously as a potential top flight club. The choice becomes either such an enormous cost shake up that fans lose interest and the club risks relegation from even the second tier or to find a rich investor happy to gamble annual losses on a possible payday should promotion be achieved.

It seems to be a very unsatisfactory way to operate but it is one that I can only really see changing if the money that currently flows like a torrent into the Premier League either dries up or is more equally distributed between the various tiers of the game.