SAAS COGS: A Simple Guide
Something that comes up a lot for my clients with a SAAS revenue stream is COGS (Cost of Goods Sold). When I take on a client, I heavily vet their COGS, and it’s surprising how, even though I fully understand it, I still have to reference my own information each time. Today, I wanted to give a short overview of why this is important and then share a short guide I made about COGS specific to SAAS business.
First, a little background…
SAAS stands for Software As A Service. It’s a software product provided to a client as a service. Common examples include Salesforce, DocuSign, Workday, etc.
COGS stands for: Cost Of Goods Sold. Sometimes it’s also called cost of sales (COS). These are the costs directly related to selling the product. Examples include cloud storage and onboarding costs.
I personally think SAAS COGS are a bit deceptive and that a SAAS business needs to pay closer attention to its Net Margin (Net Margin = Revenue - All Costs). A gross margin for SAAS business can be anywhere from 80-99%, which, if you only look at that, compared to a physical product business, that looks way more interesting. However, when you also compare Net Margin, you get a more well-rounded picture of the health of the company. Another blog for another day.
Despite my personal opinion, tracking COGS for a SAAS business is still needed. Without COGS, there is no gross margin, and there is no way to improve it.
gross margin = gross profit (revenue- COGS) / revenue
Tracking it allows you to see areas to create efficiencies in the business, such as: lowering your per-customer data cost by increasing your volume.
What’s challenging is that it’s harder to pinpoint than a physical product COGS. For a physical product, you are producing 1 product, selling that 1 product, building another product, and selling it. Gross margin is your Price- discounts - the cost of the product = gross profit, and gross margin is simply the gross profit / gross revenue. It’s fairly easy to understand what expenses are included in the cost of the product (there’s some gray there, but not as much).
Software, on the other hand, is confusing because you build the product once and then sell it over and over again without a direct cost to all the sales after the 1st sale. And, of course, there are updates, maintenance, & new features that need to be accounted for.
So what expenses go in COGS?
Download my Guide to SAAS COGS
Now that you have my guide, go find your nearest bookkeeper and make sure your chart of accounts is set up correctly and the right expenses are being accounted for in the right places. After that’s set up, find your nearest CFO to run a gross margin analysis on your numbers, set up some KPIs, and start improving that margin!
