Implications of a cash basis salary cap

Happy Tuesday, friends.  I’m encouraged by the latest progress that’s been reported on the NFL’s labor negotiations, and I decided that I would re-engage on the topic today, for the first time in awhile.  A particular reported topic in the impending deal has actually inspired me to break my recent silence.

It’s been reported in a lot of places that a salary cap will likely return, and also that the distance between the salary floor (which has always existed since 1993), and the salary cap will diminish.  That’s interesting, and it’s a victory for the players, by virtue of guaranteeing that more money will be injected into the overall operating environment.  In 2009, the salary cap was $128 million, and the floor was 87.6% of that number, or $112.1 million.  If the 2011 cap number is about the same, which is likely, but the floor is 93%, that’s theoretically an extra $224 million that has to be spent league-wide on player salaries.  (I say theoretically, because the reality is that many teams are way over the floor annually, and the increase doesn’t affect their spending.)

Even if that $224 million is more like $75 million, which is likely, we’re actually dealing with something there called a cap number.  Many of you know what that means, but for those who don’t, a cap number is an artificial measure of salary expense within a given period, which is generally comprised of a base salary, a prorated portion of a signing bonus, and incentive payments which are earned, or deemed likely to be earned.  That sounded complicated to read, I know, so an illustration is in order.

Let’s say that the Broncos signed DeAngelo Williams on July 15, 2011 under the 2009 rules, and gave him a contract with the following terms:

  1. 5-year term, running from 2011 to 2015
  2. A signing bonus of $16 million
  3. Base salaries as follows:
    1. 2011 - $3.5 million
    2. 2012 - $4.5 million
    3. 2013 - $5 million
    4. 2014 - $5.5 million
    5. 2015 - $6 million
  4. Incentives as follows:
    1. $2 million bonus for winning NFL MVP
    2. $500,000 bonus for making the Pro Bowl
    3. $250,000 bonus for rushing for 1,300 yards
    4. $100,000 bonus for participating in every offseason workout

That’s a little complicated, but it’s understandable, right?  Let’s lay out a fun little spreadsheet to show how it works.  Let’s start from the bottom.  NFL cap rules, as of 2009, require that likely-to-be earned incentives are included in each year’s salary cap figure.  If they end up not being earned, a credit is granted for the following season.  Unlikely-to-be-earned incentives aren’t counted that way, and are applied to the following season if they’re earned . 

For this purpose, we’re going to say that the workout bonus is deemed as likely-to-be-earned, and the other three are not.  This is how it looks in a table:

Contract Aspect 2011 2012 2013 2014 2015 Total
Salary 3,500 4,500 5,000 5,500 6,000 24,500
Bonus Proration 3,200 3,200 3,200 3,200 3,200 16,000
Incentives 100 100 100 100 100 500
Total Cap Number 6,800 7,800 8,300 8,800 9,300 41,000

There you have a 5-year, $41 million contract, with another $13.8 million of incentives available in the contract.  That’s how reporters would report it, and it’s easy to think of it as a contract that averages about $8 million per year over its life.  If you love Williams, you’re happy with that deal, and if not, you’re probably worried about his injury history, and thinking that $8 million per year is too much to pay any RB.

I don’t think there are many professional accountants who are writing about football, but since I’m one, I want to share some thoughts with you about the implications of a little-mentioned factor that’s reportedly key to the working concept of the new CBA.

That 93% salary floor is in terms of cash outlay, and not in terms of a cap number.  That’s a very, very important factor, because it seems to me that it would necessarily end the entire concept of a cap number.  If a team has to spend a minimum of $119 million in cash, and can’t exceed $128 million in cash in a given league year, that has some profound implications.

First of all, big signing bonuses suddenly become untenable for teams on an ongoing basis.  Take a quick look at the aforementioned Williams deal on a cash basis.

Contract Aspect 2011 2012 2013 2014 2015 Total
Salary 3,500 4,500 5,000 5,500 6,000 24,500
Bonus Proration 16,000 - - - - 16,000
Incentives 100 100 100 100 100 500
Total Cap Number 19,600 4,600 5,100 5,600 6,100 41,000

We’re talking about a Running Back here.  Is any team going to have DeAngelo Williams count 15% against their cap in the average first year of his contract?  It would take a team that wants to manage itself into a ditch.  I suppose that a case could be made to pay one or two big-ticket guys per year, and then live with their cheaper contracts in the following years, but it’s kind of a silly way to structure things.

If there aren’t so many signing bonuses anymore, players and agents will still want significant guaranteed money in their contracts, even if it’s spread over the life of the deal.  Maybe the deal gets structured to work as the prorated 2009-style deal worked, only the $16 million in guaranteed cash actually gets outlaid at a rate of $3.2 million per year.  I won’t make this even more complicated for my non-financial friends, and introduce Time Value of Money concerns, but you can see how this changes the game, even beyond that.

Nowadays, Williams gets his $16 million up front, and collects $13.3 million more in salaries and incentives through the first three years.  Then, what does he do?  He hires Drew Rosenhaus, and starts agitating for a new contract with two years left to play on his last one.  Under a cash basis, that strategy probably goes out the window.  The Broncos' owner has a legitimate five years of cost certainty on this contract, and that’s a good reason why the owners would want to switch to a cash basis.

Another good reason for the owners to be interested in it is that it levels the competitive playing field on a year-to-year basis.  The high-cash teams like Washington can go out and drop a $42 million bonus on Albert Haynesworth, and the Colts or Chargers or Dolphins could never do that.  Washington will have to eventually pay the piper, so their record is probably going to whipsaw over time, due to their financial behavior.  Those more consistent-spending teams will tend to be more consistent with their records, and their quality won’t be determined by their financial behavior.  I think that that is preferable to the other approach, and I imagine that about 25 of the 32 team owners would agree.

The important implication to the players of switching to a cash basis is that it represents a one-time potential cash bonanza.  If there’s suddenly no such thing as a cap number, that means that yesterday’s bonuses don’t matter anymore, and all that counts toward a prospective 2011 cap is 2011 salaries that are already on the books.

The Broncos will again serve as our example, and as Doug mentioned a few days ago, they currently have about $88 million in salary obligations for 2011.  If they suddenly have to spend a minimum of $31 million in the course of a couple weeks, some players are going to be getting paid.  Let’s say that the Broncos are roughly average in their 2011 salary position today, and multiply that $31 million by 32.  We’re talking about $992 million of 2011 cash that needs to be encumbered immediately.   (I think that’s conservative, actually, without doing the work to figure out where the other 31 teams are.  The Broncos have very few free agents, relative to other teams.)

The aggregate player population, for one year, gets to have its past bonuses cease to matter, and gets to collect a whole pile of new money.  Some will go to rookies, and some will go to free agents, and I’m sure teams will spend the difference in 2011 by restructuring the contracts of some of their current players, to move expense into 2011.  Whatever the case, the overall player population wins.

This whole idea sounds pretty win-win, and I’m impressed by it. Some people, who Drew from KSK hilariously described here on Deadspin want to see this be win-lose in the owners' favor, and others want to see it the other way.  It seems like some sensibility has returned to this process, and that compromise is happening.  That's the best sign that we're going to have a full football season, and that a new league year will be starting soon.

1.  I’m not in the arguing business, I’m in the saying what I think business.
2.  I get my information from my eyes.

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