What are SaaS COGS? Cost of Goods Sold (COGS) is a crucial element in the business environment, and it’s easy to understand when applied to traditional operations. However, with SaaS COGS, where you deal with software and applications instead of physical goods, determining what should be included under COGS can be difficult.
SaaS operations are more commonly known as cloud-based software, where the applications run from a central provider and can be accessed via the web or mobile browser. Unlike traditional desktop programs that must be downloaded onto your computer, SaaS is instantly accessible.
There is much software as a service company
- Atlassian Corporation
- Survey Monkey
- Sale Force
SaaS companies need to know how COGS affects gross profit and gross margins. This article will help you calculate those numbers.
The Definition of SaaS COGS
The Cost of Goods Sold is the amount to make and deliver a product. It includes costs like materials, labor, and delivery.
It is unclear which expenses should be allocated to SaaS COGS and what the appropriate methodology for doing so would be. Accounting rules are specific on certain issues but lack direction in others.
It is unfortunate that many companies are not setting goals for their sales teams because gross margins are crucial to the success of any business.
What Does SaaS COGS Have to Say to You?
COGS is a financial term that stands for Cost of Goods Sold and helps measure the cost of inputs when manufacturing goods or services. It also determines gross profit margin.
Gross profit is calculated by subtracting the cost of goods sold from revenue. It’s a metric that shows how well your business manages its production process.
A company’s cost of goods sold is a major factor in determining its profit margin. If COGS increases, there will be less profit; and the lower the COGS, the higher profits.
The Advantages of SaaS COGS
Any business needs to know the cost of goods sold because it helps calculate gross profit margin. If you know your gross profit, then you can see how much money is left over for overhead and reinvestment.
Production is one of the key aspects that determine how well a business can perform in terms of productivity and profitability.
Understanding the Cost of Goods Sold (SaaS COGS) Equation
COGS is the sum of all purchases made during a given period, minus any inventory that has been sold.
For example, if a manufacturing company has $5,000 worth of inventory at the beginning of the year and spends 15k on materials during that time period as well as delivery costs. If they ended with an amount in their inventory not sold being 4k items then their COGS would be 16K ($5000 +$15000-4000).
The costs of goods sold are calculated by adding up the total cost for items that were produced but not sold. This includes manufacturing, distribution, and other expenses incurred during production.
Gross Profit and Margin Calculation
In order to calculate the correct gross profit, a company must accurately measure its sales and SaaS COGS. This will determine whether or not there is an accurate amount of gross profit.
You can be caught off guard by how easily a small shift in one variable can cause an entire company to go bankrupt.
For the sake of clarity, we’ll provide definitions for these terms:
- Revenue is the dollar amount you get from products and services sold over a given period.
- Gross Profit is the revenues minus all costs of production. It tells you how much profit a company makes after deducting everything.
- Gross Margin is the difference between how much a company sells and what it costs to produce that product. It’s calculated by dividing gross profit (the amount of money left over after subtracting all expenses from revenues) by total sales.
The gross profit margin is the percentage of revenue that remains after deducting costs of goods sold from total sales. It’s calculated by dividing the amount leftover (revenue minus COGS) by total revenues.
In this chart, you can see the difference between a company’s gross margin. Let us consider two companies that sell items for the same price but have different costs of goods sold.
It is clear that Company A has a higher profit margin than company B.
Exclusions from the Cost-of-Goods-Sold (SaaS COGS) Deduction
A service company, like a singing teacher or an accountant, for example, will not have any cost of goods sold nor do they need to carry inventory.
When calculating profit, it is important to be aware of the costs that come with running a business. These expenses are known as the cost of services and they should not count towards COGS.
Cost of Goods Sold (COGS) vs. Operating Expenses
Operating expenses are not the same as COGS. Operating expenses come from running a business, but do not directly affect how much is spent on producing goods or services.
Operating costs are the many expenses that you will incur to run your business. These can include:
- Office supplies
- Insurance costs
- Legal costs
- Sales and marketing
A software company’s COGS is not as simple to calculate. There are several variables that make it difficult, like the cost of customer acquisition or how often people use your product.
In a traditional manufacturing business, COGS is the total cost of goods sold during an accounting period. In software-enabled services that are delivered via the internet, however, there’s a very different way to calculate this.
The cost of goods sold (COGS) for a SaaS company is different from that used by traditional software companies.
COGS: What Should Be Included?
To find out what to include in COGS, you should ask yourself if it would be possible for your company to continue without that expense. If not, then it goes into the calculations; if yes, then exclude it.
If you are selling software as a service, there are some costs that can be included in COGS if they don’t affect your operating expenses.
- Software license fees for embedded third-party apps
- Application hosting and monitoring costs
- Website development and support costs
- Customer support and account management costs
- Data communication expenses
- Costs of subscriptions
- Costs for employees directly involved in production and delivery
- Professional services and training personnel costs
Customer Success (CS)
When a customer interacts with your brand, they should be able to get what they expect. This could happen when buying the product or in non-commercial interactions like contacting you for help.
Customer service and salespeople should be at the forefront of product development. They know what customers want, they can help design new products to suit those needs, and their interaction with customers helps build a strong relationship.
CS is a complex solution and you will need to assess how it can fit into your company’s overall structure. You also need to be aware of the cost of CS.
CS under Cost of Goods Sold
Customer service is not just a nice add-on, it should be thought of as an integral part of your product. The best customer experiences come from brands that have strong connections with their customers and offer excellent backup services.
If customer service is an important part of your company, then it should be considered a COGS expense.
You can learn more about the costs of a product by placing it in this section. It will also help you understand how to design your products better and give them some backup services that may be their only edge over competitors.
One downside to making customer success a cost of goods sold expense is that it will make your product more expensive. To counter this, you need to ensure the customers understand and value what they are receiving.
CS under Sales and Marketing
If the primary focus of customer service is to generate leads during a client’s tenure, it may be best placed under sales and marketing. By placing CS here, you can help build confidence in potential clients while also making sure that they are satisfied with their purchases.
If we spend the money anyway, then why not spend it in a way that will make our company more profitable?
It is crucial to ask yourself whether you can still provide your customers with the same level of service if you did not have that expense.
What Should Not Be Included in SaaS COGS?
If you are calculating COGS, these costs should not be included:
- Payroll taxes
- Employee benefits (e.g., health insurance)
“General and administrative expenses” (G&A), which include salaries for managers who oversee the production of a product or service; accounting fees; facility rental payments if they aren’t paid to independent contractors; etc.
- Sales incentives
- Customer success costs associated with upselling
- Product development costs
- Costs associated with internal operations
- Third-party software for in-house applications
If you are looking to raise capital or sell your company, it is advisable not to get too complicated with allocations and chargebacks. If they’re in line with the industry standard of SaaS businesses, potential investors will be able to understand them.
How do you figure out the cost of goods sold (COGS)?
The industry standard for a SaaS company is to have an 80-90% gross margin, which means that their COGS would be about 10-20%.
When applying for funding or looking to investors, a company’s margins are very important because they show how profitable the business is.
SaaS companies are tricky to calculate gross margin because it is hard to define what the cost of goods sold should be. Instead, think about this as your total revenue minus any other expenses.
One of the most important and complicated aspects to running a business is determining how much it costs you.
When it comes to software services, the COGS equation is simple because there are no inventory costs. Company S had $49,000 in expenses and company T has $30,000.
Calculating a SaaS Company’s Gross Profit and Margin
Gross profits are important for any business, not just manufacturing. Sales and marketing costs, directors’ salaries, leases – all of these expenses come out of the gross profit.
Higher margins mean more money to reinvest and faster growth for the business.
Gross profit is the amount of revenue left over after you take out all expenses related to that revenue.
Let’s say Company S and T both bring in the same amount of sales. If they have the same number of employees, then paychecks should be equal.
Company T, in this example, has a higher margin and can keep more funds than Company S. The factors driving the difference are customer support, development costs for licenses, subscriptions, etc.
SaaS companies have two major costs that are staff-related. These always take up a significant amount of the budget.
Gross margin is often overlooked when it comes to company finances, but changes over time can tell you about the health of a business. A downturn in gross margins could indicate that there are underlying issues with management or problems within the market.
SaaS companies are businesses that depend on recurring revenue, and the more they can increase their gross margin over time, the better. Investors are drawn to SaaS companies with high margins and low customer turnover. This leads to better valuations for the company.
High gross margins are essential for risk mitigation and competing in a tough market. The SaaS industry is expected to continue growing, but competition will be fierce.
That is why it’s important to know the COGS and how that affects gross profit margins.
A profitable business is a healthy one. The more successful the SaaS company, the greater chance it has of succeeding.
Reviewing your financials will help you set new goals and operate an efficient operation.