As the term implies, Sources and Uses, or S&U, is often used to track the sources and uses of cash necessary to close a transaction, such as a leveraged buyout. Wise investors often utilize S&U analyses to stay abreast of funding sources and their allocation, as that is important in project and acquisition funding.
With that said, here are key insights into Sources and Uses for savvy investors.
The primary purpose of S&U is to track funding sources and allocation, with “sources” referring to where the capital necessary to complete a transaction will come from, and “uses” referring to what said capital will be spent on.
Funding sources and uses must match — they must equal each other — and an effective, at-a-glance way to track S&U to show that is through a chart or schedule.
There are steps to establishing a Sources and Uses schedule, which is usually drawn up during a deal’s financial modeling stage. To acquire a company or asset, it must first be determined how much capital is needed and where it can be obtained. The latter can be known or assumed.
Next, how the capital will be used must be established. Ample and ready reserves of working capital are necessary for any successful business, which will need cash to meet existing obligations, help with day-to-day operations, and to continue bringing in additional revenues.
There also must be “fixed assets” on the schedule under the “uses” category. Fixed assets are long-term, tangible assets such as machinery, vehicles, and buildings that are not particularly liquid and are used to produce a company’s income. Fixed assets are calculated by subtracting working capital assets from the purchase price.
Fees incurred during an acquisition, both known and assumed, must also be on the schedule.
Under source, there must be an entry for debt — typically expressed as a multiple of EBITDA. Corporate debt may include, for example, any loans, commercial paper, bonds, or debentures.
Another “sources” classification is preferred equity, the value of which is usually assumed in aggregate and combines features of equity and debt. Then there is
common equity, which is determined by subtracting preferred equity and debt from the total cash sources.
Funds allocated to project costs include:
Purchase price. A critical project component, purchase price in real estate is the amount to be paid to acquire the land and to make any improvements to structures or infrastructures. If the land is not being bought outright as part of the deal, the purchase price is then the lease-hold interest on the structure being bought.
Hard and soft costs. Hard costs are items such as materials and construction labor that directly improve the property. Soft costs are those that, while associated with the project, do not tangibly improve value. Such costs may include equity and interest reserves, capital broker and leasing commissions, loan acquisition costs, organizational and legal fees, and purchase closing costs.
The sources section also may show a project’s fund sources and capital providers such as sales of assets and owner contributions. A sale of assets occurs when a company sells at least one of its financial assets, providing the selling company with cash while the buying company profits through the purchase of assets for less value than what it provided.
Owner contributions are monies that the owner brings to the company, either through investments made in the business, their business checking account, or items they bring to the company such as equipment or furniture.
On the uses side, initial startup costs and capital asset purchases — funds a business uses to invest in long-term fixed assets — are also often factored in.
Do note the importance of tracking changes in total liabilities and how it affects funds’ sources and uses.
The chart’s sources section will largely resemble what’s called the capital stack, but there are differences.
For example, the capital stack lists the project’s capital providers and repayment priorities. Meanwhile, the sources section will go deeper and list capital providers as well, in addition to operational cash flow.
Then there is timing and complexity. While some funds are put to work at closing, others may go into escrow for insurance or taxes. Further, the debt may be broken down into initial and future funding to be drawn down when needed. By contrast, the capital stack would merely, regardless of timing, show the total debt. In any case, should the “sources” section gain more complexity, the likelihood that the project becomes more complex will also heighten.
Sources and Uses can indicate where the funding for a commercial real estate project will come from and how that capital will be used. Typically, sources can include equity from investors, loans, and net operating income from the project. Uses will likely include the purchase price as well as acquisition costs, construction and renovation costs, and the project’s yearly debt service.
Another way to assess commercial real estate projects is through what is called equity multiples, which project’s an opportunity’s return potential. The higher the equity multiple, the better.
Whether it is through fractional investment in a real estate investment trust or investment in single real estate deals — all offered by the investment platform Yieldstreet — real estate is an “alternative” investment, meaning it has a low correlation to volatile public markets.
As such, real estate also can protect against inflation, offer tax-efficient returns, and provide consistent secondary income. It also serves another very important purpose — portfolio diversification. Building a modern portfolio of varying asset types can not only potentially improve returns, but it can mitigate overall risk. In fact, diversification is a fundamental pillar of long-term investing success.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.
As a tool, Sources & Uses is helpful for providing a quick but complete understanding of a particular project’s business model and what is necessary for plan implementation. Such an analysis is particularly relevant in project funding.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.