Many different metrics are essential to understand when running a Software as a Service (SAAS) Business, such as Monthly Recurring Revenue, Churn, Net Retention, and others. COGS, or the cost of what it takes to deliver a product or service, is also among those crucial metrics.
Unfortunately, it can be one of the most challenging numbers to calculate because no Generally Accepted Accounting Principle (GAAP) outlines what information must be included in COGS. Therefore, many businesses vary in their approaches to product and service costs.
Learning about COGS and knowing how to calculate the figures accurately will allow you to determine the total cost of producing and delivering your service. Additionally, you will be able to calculate your gross profit and gross profit margin accurately.
We have outlined a few of these concepts below to help you get a basic knowledge of COGS.
What is COGS?
The Costs of Goods Sold (COGS) is the amount of money required to deliver a product or service. A traditional product involves materials, production, and delivery costs while separating overhead operating expenses like rent, commissions, and salaries.
How is COGS different for SaaS Companies?
Because SaaS products are subscription-based services delivered online, it can be challenging to calculate COGS because the enumerated costs are not precise. There are many associated costs for SaaS that do not apply to a traditional product, such as embedded third-party software, hosting and data expenses, and website development.
A general rule to follow for COGS in a SaaS company is that if you could deliver the service without the expense, do not include it in the total cost.
With a traditional or physical product, personnel-related services such as salary, commission, and customer support are not included in COGS. However, for the SaaS industry, these professional service costs are included in COGS on a case-by-case or situational basis, which is often a crucial part of delivery.
How to Calculate COGS and Gross Margin
You subtract the production cost of unsold inventory since accurate COGS only include the production costs of goods sold. However, subscription software companies do not typically have inventory carried over from year to year, so the equation is straightforward once you have determined the elements you will include. Simply add up the costs accrued during the defined period.
Having an accurate COGS is crucial because it determines your gross margin. The accepted suggestion is that your SaaS Companies’ gross margin should be 80-90%. The calculation is as follows:
Total Revenue – COGS = Gross Margin (%)
Achieving a higher margin is essential because this is overhead costs and salaries come out of this margin. Higher margins mean more investment and growth opportunities.
COGS and Capital
The COGS for your SaaS business directly affects your options for capital because lower costs of goods create higher margins and, therefore, more profitability. Having accurate calculations and high profitability increases the likelihood of willing potential investors.
At RevTek Capital, we invest growth capital and expert knowledge to help you achieve lower costs of sales for your SaaS company and increase the accuracy of your COGS calculations.
Are you ready to partner with us to help your SaaS Business thrive? We are excited to talk to you about your business and growth strategies and connect you to our network of investors. Give us a call at (602) 730-4558 to begin a conversation.