how do we understand what's a source and what's a use? I understand AR/AP, but are there other instances?
Sources vs. Uses of Cash on the Balance Sheet
Broadly speaking - sources of cash are things that yield cash and uses of cash drain the cash balance. Assets are typically a source of cash as they can be sold to gain cash and liabilities are uses of cash as they turn into an expense down the line either paying accrued expenses or long-term liabilities.
What Increases Cash?
On the balance sheet - you increase cash when you sell assets, issue equity, issue new debt, or take on other liabilities.
Assets - if you sell property, plant, and equipment or when you sell inventory (not on credit) you will gain cash. If your current assets decrease (such as accounts receivable) that means you have collected payment and your cash increases.
Liabilities - if current liabilities such as accounts payable or accrued expenses increase - that means that you have waited to pay a vendor or another party and therefore have "gained cash" in the moment by not paying an obligation.
Equity - if you issue equity - you gain cash or some other asset.
What Decreases Cash?
Cash decreases when assets other than cash increase, when a company repurchases equity, or when liabilities decline.
Assets - when you purchase an asset such as PP&E or inventory, you are decreasing your cash balance as you have purchased those items. The same can be said for current assets such as accounts receivable. Since A/R is money that you are owed by customers - you have not yet gained the cash that you have already earned and therefore that decreases what your cash balance should be.
Liabilities - if a company's liabilities are falling you are paying off deferred expenses such as accounts payable which will lower your cash balance. The same can be said with long term debt. If the company has paid back its long-term debt - that will have lowered the cash balance.
Equity - if a company repurchases its shares that will lower the cash balance. However, a fall in equity does not necessarily mean a fall in the cash balance since a negative net income flows into retained earnings. Dividends paid out can also result in a decline of cash.
Sources vs. Uses of Cash in M&A Analysis
In M&A analysis, a source and uses table shows the bankers and the companies what different kinds of capital is being used to finance the transaction and the fees and where that capital is going. Sources must equal uses so all capital must be used.
Sources include: existing cash on the balance sheet, revolver, new debt issuances, new equity issuances.
Uses include: purchasing the target's equity, repaying the target's debt or refinancing the target's debt, as well as the financing and transaction expenses.
Please refer to a video about how to build a sources and uses table below.
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