A sources and uses analysis provides a summary of where the capital used to fund an acquisition will come from (the sources) and what this capital will be used for (the uses). It is usually displayed as some kind of chart or table. The sources and the uses must equal each other, and they must total the total purchase price plus transaction costs.
Example of a Sources & Uses table:
Use of Funds
The Uses of Funds is a project-level accounting of all project costs across all categories. The Uses of Funds section is usually derived before the Sources of Funds and dictates how much funding is needed. Although there are myriad ways to group project costs, the most common is to start with three basic categories: purchase price, hard costs, and soft costs. These categories may be broken into line item sub-costs or rolled up in order to simplify the table.
Purchase Price
The purchase price is the price that the operator pays to acquire the land and any improvements, such as buildings and infrastructure. If the land is not being purchased outright as part of the transaction, then it is the price of the lease-hold interest on the building being acquired.
Hard Costs
Hard costs are items that directly improve the property such as construction labor and materials. It’s important, however, to carefully review how sponsors define hard and soft costs.
Soft Costs
Soft costs are costs associated with the project but that do not provide tangible improvement value. This category is the most varied and can include (but is not limited to):
- Purchase closing costs
- Leasing commissions
- Legal fees
- Organizational fees
- Loan acquisition costs
- Capital broker commissions
- Interest reserves
- Equity reserves
Sources of Funds
The Sources of Funds section of the table will closely match the capital stack, but it will have a few key differences.
First, while the capital stack shows the capital providers for a project and their relative order of repayment priority, the Sources of Funds section may take a deeper dive to show all of the sources of funds in a deal in addition to capital providers. One item that may be listed as a source of funds is operational cash flow. Note: the Uses of Funds should generally match the Sources of Funds, so the sponsor should include all cash flows in the table.
Another detail that the Sources of Funds section adds is the fund timing. Some funds go to work at closing, while others may be held in escrow to pay taxes or insurance. Additionally, a sponsor may break down the debt into the initial funding and future funding to be drawn on as needed. The capital stack, however, would simply show the total debt irrespective of timing. If the Sources of Funds section becomes more complex, it becomes more likely that the project itself will be complex.
Takeaways
The Sources & Uses table is not intended to provide forensic accounting. Instead, it helps to provide a funding road map for how the funds will be raised and how they will then be spent on a project. It is a useful tool for a quick understanding of a project’s particular business model and the expertise it will require to carry out.
For more information on Sources and Uses, refer to this article: Sources & Uses: Following the Real Estate Money Trail.