The Daily Technical #32: What is the difference between cost of goods sold and operating expenses?

Good morning. Welcome to the 32nd edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What levers have a positive/negative impact on the IRR of an investment?

When tackling a question on the levers affecting IRR, break it down into positive and negative impacts.

Positive IRR Levers:

• Earlier Extraction of Proceeds: Can be achieved through a dividend recapitalization, an earlier than expected sale, the receipt of cash interest (as opposed to PIK interest, for debt investors), and annual monitoring fees paid to the sponsor

• Increased FCFs: Results from strong revenue generation, EBITDA growth, and an improved margin profile – which all result in more debt being paid down throughout the holding period

• Multiple Expansion: Entails exiting at a higher multiple than the entry multiple

Negative IRR Levers:

• Delayed Receipt of Proceeds: Often caused by a sale pushed back to a later date due to lack of buyer interest or unfavorable market conditions, receipt of PIK interest (for debt investors)

• Decreased FCFs: Caused by falling short of initial forecasts or decreased profit margins from external factors (e.g., higher unit costs) – the result is less debt being paid down in total

• Multiple Contraction: Investment is exited at a lower multiple than the purchase multiple

Common Mistakes

1. Vague Explanations: Avoid skimpy details. Clearly define how each lever specifically affects IRR. Always support with logical reasoning or a relatable example.

2. Confusing Cash with Accounting Profits: IRR is all about cash flow, not just profits on paper. Ensure clarity in distinguishing between actual cash inflows and accruals.

Key Takeaways / TLDR

• Boost IRR with quick cash recovery, growing cash flows, and a premium exit multiple.

• IRR suffers from payout delays, declining cash flows, and exiting at a lower multiple.

TODAY’S QUESTION
What is the difference between cost of goods sold and operating expenses?

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THAT’S A WRAP
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See you tomorrow,

The HirePrep Team