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Friday, August 19, 2011

The NFL Salary Cap System 101


The NFL Salary Cap System 101


What is the salary cap?

The NFL Salary Cap is quite simply an accounting method for recording player salaries that is distinct and different than cash accounting. 

It is very important to understand that what makes the NFL system very different from other professional salary caps is that every dollar spent on players salaries MUST eventually be accounted for in the salary cap system (i.e. there is no buy-out or way to circumvent the amounts spent).

This is the Golden Rule:  Every dollar given to a player will eventually get to the salary cap!

In general, the portion of a player’s salary that is subject to accounting differences is something called a “signing bonus”, which is normally a lump sum payment to a player at the time the contract is signed or at other specific times during the deal (sometimes signing bonuses are split over two or more seasons).

The signing bonus is distinct from other types of salary an NFL player gets from ownership.  We must understand each of the basic types as follows because to understand the salary cap we must understand cash flow.

1.  Annual Salary (or Base Salary)
Each NFL player must have a minimum base salary.  This salary is paid out in 17 equal pay checks, each week, during the NFL season (including the bye week).  For young players (those with 3 years or less in service), annual salary is NOT guaranteed at any time.  So a 2-year veteran that is released after week 10, would only receive (in cash), 10/17th of his base salary.  After week 10, he receives nothing.  For a veteran player (4+ years of service), their annual salary is guaranteed the minute they make the opening 53-man roster (they would continue to get a weekly paycheck, even if released during the year).  Note if a veteran player is signed after week 1, then their salary is NOT guaranteed and really becomes a week-to-week pay as you go salary.

2.  Roster Bonus or Workout Bonus
I lump these type of bonuses together because both CAN NOT be amortized (I’ll get to that more later).  These lump sum payments occur between March and the start of the season and can be triggered for any reason agreed to by the parties.  Most roster bonuses trigger before free agency on the league calendar to force a team to make a cash decision on the player as soon in the league year as possible.  For accounting purposes, Roster and Workout Bonuses CAN NOT be amortized on the salary cap books.

3.  Signing Bonus
As stated above, a signing bonus is a lump sum payment either at the time of signing or elsewhere that CAN be amortized for the purpose of salary cap accounting.  The mathematics behind how to apply signing bonuses to the salary cap books is really the heart and soul of understanding the NFL salary cap.

4.  Performance Bonus
For the purpose of understanding the basics of the salary cap, we don’t need to dwell on performance based bonuses.  In general, on a year-to-year basis, a performance based bonus is either considered likely to be earned (and thus projected on the salary cap books like roster bonus) or not likely to be earned (not projected anywhere in the salary cap books at all).  If what you “guessed” at the beginning of the year (likely or unlikely) changes, a team must make adjustment to their salary cap accounting the following year (by either adding or subtracting money to their overall salary cap).  There is no amortization of performance bonuses.  Performance bonuses are paid AFTER the season (in the window between the Super Bowl and the end of the league year).

Remember, once a contract is signed, it is more a matter of following the CASH and knowing how to get the cash onto the salary cap books that is most important to understanding the salary cap.

Let’s look at the simple parts of a typical NFL contract:

Here is how Alan Faneca’s contract looked when he signed as a free agent with the New York Jets in 2008:

2008
Base Salary = $1.0M
Signing Bonus = $4.2M
Roster Bonus = $3.8M

2009
Base Salary = $7.0M
Roster Bonus = $250k

2010
Base Salary = $7.5M

2012
Base Salary = $8.0M

2013
Base Salary = $8.25M

This contract is a fairly typical 5-year, $40 million deal.  From the perspective of cash, this contract pays Faneca $9 million in 2008, then $7.25M, $7.5M, $8M and $8.25M.  If cash and salary cap accounting were the same, this is what the salary cap values would also be.  But that is not the case.

As stated above, the $4.2M signing bonus can be amortized for up to FIVE YEARS over each year of the contract.  So for salary cap accounting, that $4.2M is divided by 5 years and allocated on the salary cap books as $840k/year.

Therefore the projected salary cap charges for Faneca are:  $5.64M, $8.09M, $8.34M, $8.84M and $9.09M respectively from 2008 to 2013.

Please note (important!) that the TOTALS of both cash accounting and salary cap accounting equal $40M million!

Let’s show another example:

Dunta Robinson signed a 6-year, $57 million contract in 2010 with the Atlanta Falcons.  His contract is structured as follows:

2010:
Base Salary = $5.0M
Roster Bonus = $7.0M

2011:
Base Salary = $5.5M
Signing Bonus = $5.00M

2012:
Base Salary = $6.0M
Signing Bonus = $3.0M

2013:
Base Salary = $7.0M

2014:
Base Salary = 9.0M

2015:
Base Salary = $9.5M

Again, the values above that can be amortized are the signing bonus in 2011 ($5 million) over the remaining 5 years of the contract AND the signing bonus in 2012 ($3 million) over the remaining 4 years of the contract.

The $5 million gets applied as a $1 million salary cap charge from 2011 to 2015, while the $3 million get split up as $750k each year from 2012 to 2015.

So here is cash vs. salary cap accounting of the Dunta Robinson contract:

2010:  $12M cash, $12M salary cap
2011:  $10.5M cash, $6.5M salary cap
2012:  $9M cash, $7.75M salary cap
2013:  $7M cash, $8.75M salary cap
2014:  $9M cash, $10.75M salary cap
2015:  $9.5M cash, $11.25M salary cap

Once again, the important realization is that both cash AND cap will equal the same $57 million value if and only if the contract is completed.  There are no tricks to avoid this.

If you have followed along to this point, we are now ready to expand what we know into situations that arise during contracts.  As always, the key to remember is cash HAS TO eventually equal cap.


Contract Termination

One of the most common things to happen in the NFL is a players release during a contract.  This happens to dozens of players each off-season and can happen any time from the beginning of the league year up to deciding the team’s final 53-man roster (and even during the season).

When a player is released (or traded), the difference between that players’ CASH accounting and SALARY CAP accounting must be realized.  If any signing bonus was amortized at all there will be a difference.  This difference is often called “dead money”.

How “dead money” is applied to the salary cap books can be a bit complex, but understand teams HAVE to even out the difference over a maximum TWO-YEAR window on the books.  In the first year (the year of release), a team can short-change the amount down to the previously amortized signing bonus amount, with the remainder on the 2nd year salary cap books.  But teams can also choose to apply ALL of the dead money that first year.  This decision really depends on what is best for the clubs and their books.

For example, let’s look at Sean Mahan, the center signed by Pittsburgh in 2007 for 5-years, $17M contract.  Mahan’s contract was simple:

2007:  Base Salary = $650k, Signing Bonus = $4M
2008:  Base Salary = $2.175M
2009:  Base Salary = $3.175M
2010:  Base Salary = $3.5M
2011:  Base Salary = $3.5M

Mahan earned $4.65M in pay during 2007 from the Steelers, but his salary cap charge was only $1.45M (the $4M signing bonus was amortized into five 800k parts).

When Sean Mahan was traded in August of 2008 back to Tampa Bay, a correction to the salary cap books HAS to take place because Mahan’s CASH expense to date was $4.65M while his salary cap allocation to date was only $1.45M.  There is a $3.2M difference that becomes “dead money” for the Steelers to account for.  The rules also state, this “dead money” must be taken care of in the next two fiscal years.

The Steelers choose to account for $800k on their 2008 salary cap books (which is 1/5th of Mahan’s signing bonus) and the remaining $2.4M onto their 2009 books.  Note the Steelers could have chosen anything from $800k up to all $3.2M that first year, but selected the minimum amount due to other salary cap issues.

Again, when looking back in history at Sean Mahan alone, we see a CASH accounting of $4.65M all in 2007 but a salary cap accounting of $1.45M, $800k and $2.4M over a 3-year historic window.  There were no “tricks” to get out of the golden rule.  The money the Steelers paid Mahan did eventually get onto the Steelers salary cap books at some point.  It is just a matter of when.

Contract Renegotiation

When a player renegotiates with a team mid-way through a contract, what is effectively happening is the OLD contract is ripped up and a NEW contract is signed, but the previous allocations of signing bonuses stay in place.

Renegotiations fall into three categories (and using the correct vocabulary term will help your understanding of what is happening):

Restructuring is when a team agrees to pay the player the exact same amount of money for a season but changes how that money is paid for amortization purposes.  This means turning a high base salary into a combination of signing bonus and lower base salary (remember, every player has to have a minimum base salary based on his years of service).

Extensions are when the new contract adds years to the contract.  This is most often (not always) is associated with a pay raise and agreement with a player well liked in the organization.  The media likes to discuss “new money”, but I strongly encourage you to realize an extension is actually a NEW contract and the old contract is in fact ripped up.  All that remains from the previous contract is the amortized values of previous signing bonuses.

Renegotiations, although a catch-all phrase, really means among NFL executives a new contract that changes the scheduled compensation to the player for that year.  Renegotiations can go up but often are used to lower player salaries instead of releasing that player.

There is no simple way to show renegotiations without examples.  The math is still the same, but you often start dealing with multiple signing bonuses and their amortized values.  Remember that a signing bonus can only be amortized over a maximum 5 year period.

In some cases veteran players go through MANY renegotiations during their career.  Renegotiations happen for the following main reasons:

1.  To give a raise or lock up a player to a long term contract BEFORE the player becomes a free agent.  This is common as the player gets his deal (and signing bonus) often a year or more earlier, avoids risk of injury and in return might give the team a slight discount than what he would gain negotiating with multiple teams.

2.  To renegotiate a lower base salary for a player if he is not performing up the level of his projected salary and is likely headed for release/trade.

3.  To make short-term salary cap room by converting BASE SALARY into SIGNING BONUS, thus making salary that was previously unamortorized into an amortized amount over the remaining years of the contract.  This often does NOT include adding years onto the contract, but can be combined with reason #1 or #2 if necessary.

Let’s look at some simple examples:

In spring of 2009, Hines Ward was entering the last year of his 2005, 5-year contract with the Pittsburgh Steelers.  Ward was scheduled to make $5.8M dollars as base salary and have a salary cap amount of $8.133M due to previous amortized signing bonuses ($5M/5 years from 2005 and $4M/4 years from 2006) and a surprise performance bonus ($333k related to the 2008 Super Bowl).

The Steelers renegotiated Hines Wards deal as follows:

2009:     Base Salary = $2.75M, Signing Bonus = $3.05M
2010:     Base Salary = $4M
2011:     Base Salary = $3M, Roster Bonus = $1M
2012:     Base Salary = $4M
2013:     Base Salary = $4M

The key to deducing what Hines Ward’s new salary cap values are is to realize we still need to carry the previously amortized amounts from his last contract in 2009.

It is the 2009 salary cap value that is tricky.  His previous signing bonuses in 2005 and 2006 each amortized to $1M/season, so that adds $2M onto Ward’s 2009 salary cap charge.  His NEW signing bonus of $3.05M, which gets equally divided from years 2009 to 2013, will add $610k.  His new base salary is $2.75M.  And we need an adjustment to carry the $333k Ward was paid as a surprise performance bonus in 2008.

So Hines Ward’s new 2009 salary cap charge is:  $2.75M (BS) + $1.0M (SB ’05) + $1.0M (SB ‘06) + $610k (SB ‘09) + 333k (Performance Bonus) = $5.693M.

Once we get past 2009, the money paid Hines Ward as signing bonuses in 2005 and 2006 will now be “off the books” and his salary cap charge becomes just his base salary plus the amortized signing bonus of 2009 ($610k per year).  So Ward’s 2010 cap charge is simply $4M + $610k = $4.61M.

Remember, you cannot “refinance” how to amortize a signing bonus.  You can’t continue to split it into smaller and smaller pieces over longer time frames.  Even when you renegotiate a contract how a signing bonus was previously amortized remains on the salary cap books as originally planned.

One last note; Hines Ward neither received a pay raise nor pay cut with the above renegotiation.  His 2009 take-home pay remained identical at $5.8M.  Only the structure of the money changed (turning base salary into a signing bonus).

The fact Ward’s take-home pay didn’t change leads us to another common use of renegotiation to try and make salary cap room.  An example of this occurred with Ike Taylor in 2008.

Ike Taylor signed a long term, 5-year deal with the Steelers in 2006 after his rookie contract.  Heading into the 2008 off-season, Ike Taylor was on the salary cap books as follows for the remaining three years of his contract (consider this a snap shot in time):

2008:  $4.09M Base Salary, $300k Roster Bonus, $1.35M Signing Bonus Allocation = $5.74M CAP
2009:  $3.5M Base Salary, $250k Roster Bonus, $1.35M Signing Bonus Allocation = $5.1M CAP
2010:  $3.5M Base Salary, $250k Roster Bonus, $1.35M Signing Bonus Allocation = $5.1M CAP

In spring of 2008, the Steelers organization needed salary cap room for other uses, therefore they renegotiated Ike Taylor’s contract by converting his 2008 base salary of $4.09M into a base salary of $1.09M and a new signing bonus of $3M.  This $3M signing bonus was allowed to then be amortized over the remaining three years of the contract.  No other changes to the deal were made.

Let’s look at the effect this renegotiation had on Ike Taylor’s projected salary cap charges:

2009:  $1.09M Base Salary, $300k Roster Bonus, $2.35M Signing Bonus Allocation = $3.74M CAP
2010:  $3.5M Base Salary, $250k Roster Bonus, $2.35M Signing Bonus Allocation = $6.1M CAP
2011:  $3.5M Base Salary, $250k Roster Bonus, $2.35M Signing Bonus Allocation = $6.1M CAP

This is a very simple example of how a team can push forward some salary cap dollars into future years.  There are risks associated to the team when doing this however because Ike Taylor becomes much more difficult to release or trade at the tail end of a contract.  There is additional liability in potential “dead money” now in both 2010 and 2011.

Conclusion

The examples above, if you can follow the mathematics, explain about 99% of all current contracts in the NFL.   There are a few more “advanced topics” if you are interest I will explain with some questions and answers:

1.  I often hear about “guaranteed” money when a contract is signed.  What is this and does it affect the salary cap?

A:  In recent contracts it has become more common for teams to guarantee payment of either roster bonuses, base salaries or both after the first year of the contract.  If and when a player is released PRIOR to these guarantees, then yes this can affect the salary cap books.  Consider some of these guarantees as severance packages.  And since this is cash spent, all severance payments have to find their way to the salary cap books eventually.

2.  Can you explain performance bonuses in any more detail?

A:  Sure.  Like I stated above performance bonuses get labeled “Likely to be Earned” (LTBE for short) or “Unlikely to be Earned” (UTBE).  How and who decides this is a bit fuzzy, but the league office is involved and scrutinizes teams on their assumed choice.  For year-to-year salary cap analysis, LTBE bonuses are simply treated as additional base salary and are applied to the current salary cap.  What gets interesting is when a LTBE bonus isn’t met.  Because the team carried that LTBE value on their salary cap books for the previous year, the team gets a salary cap “credit” the following year.  This credit is applied (get this) as an increase in the team’s allowable salary cap!

Effectively, what teams can do is take extra salary cap room from one season and bank it for use in future years.  New England and Philadelphia are famous in salary cap circles for doing this.

The easiest example I can give on how to do this would be if a team is interested in promoting a backup player into a starting role and signs them to a new, expensive, long-term contract.  Since many backup players participate in special teams, a team could create a large performance bonus based on special teams participation (either total snaps or % of snaps).  Since this former backup player reached these special teams milestone the previous season(s), it can be considered LTBE.  But if that team fully knows that player will NOT participate in special teams after his promotion to a starter, that performance bonus will never get paid (and all the parties know this).

Thus in year one of that players new contract, this huge LTBE bonus (and it can be any fictitious amount) is carried on the teams salary cap books but when it is fact the bonus was never paid (after the season), this LTBE bonus becomes a credit to the next year’s salary cap.

In the case of UTBE bonuses, there are no tricks like this.

3.  Are Signing Bonuses always amortized equally over the contract?

A:  As far as I can tell yes, but there is no rule I see that says it’s a requirement.  I believe a signing bonus can be amortized to “front-load” the value, but I have never seen an example of that done by any team.  I know for sure you cannot “back-load” a signing bonus.  Also note, the maximum number of years a signing bonus can be amortized is five years, even if the contract is longer than that.

4.  Does June 1st mean anything?

A:  Not really.  In the old days, June 1st was a demarcation line that changed the way teams could spread out dead money over the following two seasons.  But that date has effectively been removed with exemptions.

5.  Is there a method on how/when teams have to be in compliance with the salary cap?

A:  Yes.  The NFL financial year starts on March 1st (this is officially the day a new season starts for NFL teams).  Between March 1st and the start of the regular season, teams only count their highest projected 51 players against the salary cap (this is often called the Rule of 51).  This obviously allows teams to have the 80-90 roster players during OTA’s and training camp without worrying about all their salaries.  A few days before the actual season starts (the week after Labor Day), teams decide on their 53-man rosters.  At this point, all 53 players now count on the salary cap books.  Teams have to leave room for practice squad week-to-week salaries and also room for replacement players if anyone gets injured.  During the season, to be salary cap compliant all these minor changes to your 53-man roster have to be under the current salary cap for the league year.

6.  Do injured players count on the salary cap?

A:  Yes.  If a player is placed on Injured Reserve, his full salary becomes guaranteed and that salary remains on the salary cap accounting books.  If a player is released due to injury, often an “injury settlement” takes place.  Again, this is similar to a severance package and those payments must be accounted for on the salary cap books (almost always in the current year).

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