Understanding how a company allocates its capital is crucial for investors, analysts, and financial leaders. By examining the sources & uses of funds, you can gain insights into management’s priorities, financial discipline, and strategic direction. In this article, we will demonstrate a step-by-step approach to performing this analysis, using the Australian online furniture retailer Temple & Webster (ASX:TPW) as an example.
We will cover how to identify where funds are coming from (sources), where they are going (uses), and what these choices say about the company’s strategy.
Step 1: Gather Two Comparable Balance Sheets
Begin by looking at the company’s balance sheet at two points in time—say, 30 June 2023 and 30 June 2024. In this article, we will look at figures from Temple & Webster’s FY24 Investor Presentation. The year-over-year changes in various line items help you determine whether those changes represent inflows (sources) or outflows (uses) of funds.
For example, consider simplified key figures (in A$ millions):
| Line Item | 30-Jun-23 | 30-Jun-24 | Change |
|---|---|---|---|
| Cash & Cash Equivalents | 105.1 | 116.4 | +11.3 |
| Inventories | 18.1 | 26.5 | +8.4 |
| Trade Payables | 34.2 | 45.2 | +11.0 |
| Deferred Revenue | 13.7 | 21.2 | +7.5 |
| Contributed Equity | 114.5 | 101.9 | -12.6 |
| Investment in Renovai | 3.0 | 0.0 | -3.0 |
Step 2: Classify Each Change as a Source or Use of Funds
Sources of Funds (Inflows):
- Operating Cash Flow Elements:
An increase in Trade Payables (+11.0m) means the company is effectively using supplier credit, holding onto its cash longer. Similarly, Deferred Revenue (+7.5m) means customers have paid in advance, providing immediate cash. Both represent sources of funds that bolster short-term liquidity.
Uses of Funds (Outflows):
- Organic Growth:
A rise in Inventories (+8.4m) suggests the company is investing cash in stock to meet future demand. This ties up capital and is therefore a use of funds. - Share Buybacks:
The decrease in Contributed Equity (-12.6m) reflects a $12.6 million share buyback. This directly consumes cash as the company returns money to shareholders by purchasing its own shares. It’s a strategic capital allocation choice aimed at optimising the capital structure or signalling confidence in the company’s future. - Write-Off of Renovai Investment:
Although the Investment in Renovai (-3.0m) line item declined to zero, this was a full write-off rather than a cash-generating divestment. A write-off is a non-cash accounting charge—no funds actually flowed back into the company. Thus, it is neither a source nor a use of cash. Instead, it’s a reduction in an asset’s book value on the balance sheet.
Step 3: Summarise the Impact or Sources & Uses of Funds
Sources of Funds:
- Trade Payables: +11.0m
- Deferred Revenue: +7.5m
These add up to +18.5m from operational working capital changes.
Uses of Funds:
- Inventories: -8.4m
- Share Buyback: -12.6m
These uses total -21.0m.
Net Effect:
The identified sources (+18.5m) are slightly lower than the identified uses (-21.0m), implying that other items (not shown in our simplified table) contribute to the final change in cash. In the actual financial statements, additional factors like minor asset sales, tax payments, or non-cash items would explain the exact reconciliation to the observed +11.3m increase in cash.
Step 4: Draw Conclusions About Capital Allocation
By examining Temple & Webster’s sources and uses of funds, we see the following capital allocation patterns:
- Focus on Organic Growth:
The increase in inventories indicates management’s commitment to expanding product availability and ensuring seamless customer experiences. This supports the company’s core operational strategy. - Returning Capital to Shareholders via Buybacks:
The $12.6 million share buyback shows that Temple & Webster is willing to return excess capital to shareholders, rather than only reinvesting in the business. This could signal confidence in future cash generation and the desire to optimise the capital structure. - Operational Cash Generation and Working Capital Levers:
Higher trade payables and deferred revenue show effective working capital management. These short-term sources of funds improve liquidity without taking on additional debt or issuing new shares. - No Inorganic Growth from Divestment:
The write-off of the Renovai investment is an accounting adjustment, not a cash inflow. With no major acquisitions or disposals providing cash, the company’s approach does not currently rely on inorganic growth to fuel its expansion.
Step 5: Applying This Method to Other Companies
This exercise demonstrates how year-over-year balance sheet changes reveal a company’s financial moves. By methodically examining whether changes in asset, liability, and equity accounts represent a source or a use of funds, you gain insight into management’s priorities—be it reinvesting in operations, returning cash to shareholders, or restructuring the business.
You can apply the same steps to any company:
- Identify and categorise changes in balance sheet items.
- Determine which changes provide cash (sources) and which consume it (uses).
- Summarise the net effect and interpret the strategic implications.
Final Thoughts
A sources and uses of funds analysis is a powerful tool for understanding a firm’s capital allocation strategy. In the case of Temple & Webster, the numbers show a balanced approach: investing in organic growth while also delivering value to shareholders through share buybacks. At the same time, the company manages working capital effectively, which supports a healthy cash position and flexibility for future opportunities.
By following these steps, you can unlock valuable insights into any company’s financial story.
