Sports organizations such as the department of sport and recreation (2016), Sask Sports Inc (2016), and Sport Nova Scotia (2016) are regularly preparing annual reports for each yearly operation. However, Sask (2016) and Nova Scotia (2016) are only presenting their statement of revenue and expenditure while the government of western Australia (2016) presented a full set of financial statements, which includes the statement of financial position. The financial position of the Australian department revealed that the sport organization has a smaller value for their total debt at only AUD$5.41m when compared to the equity of AUD$147.82m (Department, 2016). This means that the organization is primarily dependent on the use of equity financing rather than debt financing (Grinblatt and Titman, 2002).
Public and Private Funding
But the US Sports Academy (2008) stated that some sports organizations can use both public and private financing especially with regards to the development of recreation facilities. The reason for this is that public funding can include naming rights, sponsorships, lease agreements, and concession rights aside from land contributions and tax deductions (US, 2008). These are usually funded by sales taxes in order to improve tax revenues (US, 2008) but the additional benefit is that these recreation facilities reflects the economic development of its location (Baade and Matheson, 2011). This was seen in the ticket sales revenue from Sasks (2016) and the user charges and fees from the Australian department (2016). Unfortunately most governments are usually risk averse when it comes to fully funding some recreation facilities since the benefits may not be substantial (Minnesota, 201). This means that some sports organizations would have to make use of private funding to lessen the construction costs (Baade and Matheson, 2011) as seen in San Francisco, Washington, and Canada (US, 2008).
The main problem of most sports organizations is that the generated revenues from various sources are not enough to cover their operating expenses (Bajaras and Rodriguez, 2014). This was seen in the $27,612 operating revenue for Sask, wherein it will turn to a negative figure when the grant and contract revenues worth $6.8m are removed (Sask, 2016). It means that using only a single source for generating revenue will eventually lead to financial difficulties for most sports organizations such as the European football organization (Bajaras and Rodriguez, 2014). The main reason given is that its operating costs were higher than its generated revenues as concurred by the Australian department with AUD$86.76m in costs while the revenues was only AUD$6.32m without the income from the State Government (Department, 2016).
Debt and Equity Funding
For profit organizations makes use of either debt funding or equity funding depending on their company goals or strategies (Grinblatt and Titman, 2002). Brealey, Myers and Allen (2014) suggested that the optimal debt policy is at 100%, which is perceived to be an extreme measure. The reason for this is that if the debt levels of an organization increases then its company and shareholder value will also increase (Brealey, Myers, and Allen, 2014). This is because of the tax effects of a higher debt level wherein the interest payment will result in a decrease in tax payments (Brealey, Myers and Allen, 2014). One problem of a significantly high debt level is if the company can generate profits after the payment of interest, taxes, and operating costs (Berk, DeMarzo, & Harford, 2012).
Some companies however can survive and even remain profitable with a low debt ratio since they are primarily dependent on the use of equity financing (Brealey, Myers and Allen, 2014). The reason given by Brealey, Myers and Allen (2014) is potential bankruptcy costs due to difficulty in paying off the borrowing costs. This is because for-profit and not-for-profit organizations do not have a steady source of revenues and therefore can incur difficulties in generating enough cash to pay off the loan interest (Brealey, Myers and Allen, 2014). This is especially problematic when the organization increased its dependence on debt financing resulting in higher interest costs and a dwindling tax advantage (Brealey, Myers and Allen, 2014). Brealey, Myers and Allen (2014) reveal that this is a trade-off result in order to achieve an optimal capital structure.
Pecking Order Theory
The first funding option of the company must first come from internal sources of finance as suggested by the pecking order theory (Berk, DeMarzo, & Harford, 2012). Internal sources of funds are usually from cash generated by operating activities, financing, and investing activities along with the retained earnings (Berk, DeMarzo, & Harford, 2012). The main source of short-term internal funding is from operating activities since these are usually generated within an accounting cycle (Berk, DeMarzo, & Harford, 2012). The source of long-term funding are from financing or investing activities since these are generally acquired and will be paid for by the company after more than an accounting year (Berk, DeMarzo, & Harford, 2012). Retained earnings are another source of internal funding since the net income for the year can increase or decrease depending on the amount paid to shareholders through dividends (Brealey, Myers and Allen, 2014).
The next funding alternative is to make use of external funding, which are initially from debt and the last option is from equity (Berk, DeMarzo, & Harford, 2012). Debt funding are primarily used by organizations when internal sources of funding are not enough for their operating needs, which includes hybrid securities, convertible bonds, and bank loans (Grinblatt and Titman, 2002). Berk, DeMarzo and Harford (2012) suggests that short-term loans are used when agency costs are high especially if the organization needs to minimize wasteful spending. Long-term debt are normally used when the organization needs to acquire profitable investments that will generate future revenues and profits since it will require changes in the capital structure (Berk, DeMarzo and Harford, 2012).
Funding Recommendation
Bajaras and Rodriguez (2014) recommends that sports organizations must initially use internal funding since it requires the reduction of operating costs to increase organizational profits. This could be further enhanced by an increase in the generated revenues, which Bajaras and Rodriguez (2014) suggested can come from member contributions and other revenue sources. The problem is that Bajaras and Rodriguez (2014) ignores the pecking-order theory by suggesting that the next step is through the issuance of shares instead of using short-term or long-term debt. The reason for this is that debt financing is less common in sports organizations since it is normally classified as a non-profit organization (National, 2016). The frequent use of equity capital for sports organization is that it only requires the new shareholder to have a permanent stake in the organization.
Bibliography
Baade, R. A., and Matheson, V. A. (2011). Financing Professional Sports Facilities. North American Association of Sports Economists. [online] Working paper 11-02, 1-32. Available at http://college.holycross.edu/RePEc/spe/MathesonBaade_FinancingSports.pdf
Bajaras, A., and Rodriguez, P. (2014). Spanish Football in Need of Financial Therapy: Cut Expenses and Inject Capital. International Journal of Sport Finance, 9.1: 73-90.
Berk, J., DeMarzo, P., & Harford, J. (2012). Fundamentals of Corporate Finance, 2nd ed. Boston: Prentice Hall.
Brealey, R. A., Myers, S. C. and Allen, F. (2014). Principles of Corporate Finance, 11th ed. New York, NY: McGraw-Hill Irwin.
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Sport Nova Scotia. (2016). 2014-2015 Annual Report. [online] Sport Nova Scotia. Available at http://www.sportnovascotia.ca/Portals/0/docs/reports/annual/2014/
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