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Surprisingly, GAAP does not have a clear definition of what should be included in a SaaS company’s Cost of Services (COS), also commonly called Cost of Goods Sold (COGS), so each company is pretty much left to their judgment on what should be included. Having reviewed thousands of SaaS company financials, we have seen the full range of COS definitions, and through that exposure, we have come up with the recommendation outlined below
About Techcelerate Ventures
Tech Investment and Growth Advisory for Series A in the UK, operating in £150k to £5m investment market, working with #SaaS #FinTech #HealthTech #MarketPlaces and #PropTech companies.
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www.saas-capital.com
COGS
PAGE 1
SAAS GROSS MARGINS: BENCHMARKS AND DEFINITIONS
Surprisingly, GAAP does not have a clear definition of what should be included in a SaaS company's Cost of Services (COS),
also commonly called Cost of Goods Sold (COGS), so each company is pretty much left to their judgment on what should
be included. Having reviewed thousands of SaaS company financials, we have seen the full range of COS definitions, and
through that exposure, we have come up with the recommendation outlined below. This recommendation is derived from
three factors:
1.
It is generally the most common definition we see.
2. Using a common definition allows your company's financials to be easily compared to others.
3. We believe it to be the most useful from a management perspective.
First off, if your company has more than a negligible amount of professional services revenue from implementations or
ongoing services, it is a good idea to report those costs and revenues separately. Implementation is a different business
than the ongoing provisioning of a SaaS
product, and a company should not mix the
revenue and cost of each because it obscures
the core economics of both businesses.
Without knowing a gross margin on just
SaaS license revenue, things like CAC Ratios
cannot be accurately computed. Also, a SaaS
business should absolutely know it is making
or losing money on professional services, and
it should be doing so intentionally.
In terms of COS for the core SaaS revenue we recommend the following:
1. Hosting Costs
2. Employee costs related to keeping the production environment running
3. Employee costs for customer support/success of the application, but excluding costs for upsells, or cross-sells
4. Cost of any third-party software or data that is included in your delivered product
5. Any other direct employee costs required to deliver the ongoing service
These are all direct and primarily variable costs required to deliver the SaaS application. Generally speaking, if these
expenses were not paid, the provisioning of the product and service to the installed base of customers would stop or
deteriorate quickly.
Hosting costs should also include all core communication costs and depreciation on any owned assets. Customer/technical
support and customer success should include the salary and other direct costs of the CS team that is primarily focused on
retention. If a major portion of the CS team's effort is on upselling and cross-selling, those costs should be shifted to sales.
The salaries of the team responsible for keeping the production instance of the software up and running should also be
included in COS. All other R&D expenses should not be in COS.
BENCHMARKS AND DEFINITIONS: COGS
Cost of Goods
Jan
Feb
Mar
Hosting Expenses
$8,750
$9,000
$9,625
Internal Engineering Support
$4,100
$4,300
$4,000
Customer Support
$12,300
$14,000
$14,500
Third Party and/or Transaction Fees
$3,500
$3,600
$3,850
Professional Services
$32,000
$30,000
$35,000
Total CoGS
$60,650
$60,900
$66,975
www.saas-capital.com
COGS
PAGE 2
ABOUT SAAS CAPITAL
SaaS Capital is the leading provider of long-term Committed Credit Facilities to SaaS
companies. Focusing exclusively on the SaaS business model, SaaS Capital delivers faster
decisions, more capital, and longer commitments. SaaS businesses have used SaaS Capital's
Committed Credit Facilities, instead of equity, to finance growth and create hundreds of
millions of dollars in enterprise value without sacrificing significant ownership or control.
Also, through its partnership with DH Capital, a boutique investment banking advisory firm,
SaaS Capital can assist with M&A and capital raising services. SaaS Capital has offices in
Cincinnati, New York, and Seattle.
Visit www.saas-capital.com to learn more.
810 SEVENTH AVENUE, SUITE 2005 | NEW YORK, NY 10019
1225 HAYWARD AVENUE | CINCINNATI, OH 45208
7900 E GREENLAKE DRIVE NE, SUITE 206 | SEATTLE, WA 98103
IWWW.SAAS-CAPITAL.COM
TODD GARDNER | FOUNDER AND MANAGING DIRECTOR | TGARDNER@SAAS-CAPITAL.COM | 513-368-4814
ROB BELCHER | MANAGING DIRECTOR | RBELCHER@SAAS-CAPITAL.COM | 303-870-9529
The above definition is most consistent with what we see day-to-day and provides management with a solid view of the
company's contribution margin. Management can then decide how to invest that contribution margin back into sales,
marketing and product development on a discretionary basis.
Things not to be included in COS that we sometimes see included are:
1. Sales commissions
2. Amortized software development costs (we discourage capitalizing these costs in the first place)
3. Product management costs
4. Customer success costs focused on cross-selling or upselling
We also discourage the allocation of other overhead costs into COS. These are not direct variable costs, and allocation
processes are time consuming and generally inaccurate.
The core gross margin on SaaS license revenue is an important metric for all SaaS businesses. Gross margins on SaaS license
revenue for companies in our portfolio and our survey data of over 700 private SaaS companies, as defined above, are
generally 80% to 85%. Lower gross margin businesses might do very well, but they are fundamentally different in the way
they are valued and operated.
For more on SaaS accounting best practices, please see: What Should a SaaS Income Statement Look Like?
COGS
PAGE 1
SAAS GROSS MARGINS: BENCHMARKS AND DEFINITIONS
Surprisingly, GAAP does not have a clear definition of what should be included in a SaaS company's Cost of Services (COS),
also commonly called Cost of Goods Sold (COGS), so each company is pretty much left to their judgment on what should
be included. Having reviewed thousands of SaaS company financials, we have seen the full range of COS definitions, and
through that exposure, we have come up with the recommendation outlined below. This recommendation is derived from
three factors:
1.
It is generally the most common definition we see.
2. Using a common definition allows your company's financials to be easily compared to others.
3. We believe it to be the most useful from a management perspective.
First off, if your company has more than a negligible amount of professional services revenue from implementations or
ongoing services, it is a good idea to report those costs and revenues separately. Implementation is a different business
than the ongoing provisioning of a SaaS
product, and a company should not mix the
revenue and cost of each because it obscures
the core economics of both businesses.
Without knowing a gross margin on just
SaaS license revenue, things like CAC Ratios
cannot be accurately computed. Also, a SaaS
business should absolutely know it is making
or losing money on professional services, and
it should be doing so intentionally.
In terms of COS for the core SaaS revenue we recommend the following:
1. Hosting Costs
2. Employee costs related to keeping the production environment running
3. Employee costs for customer support/success of the application, but excluding costs for upsells, or cross-sells
4. Cost of any third-party software or data that is included in your delivered product
5. Any other direct employee costs required to deliver the ongoing service
These are all direct and primarily variable costs required to deliver the SaaS application. Generally speaking, if these
expenses were not paid, the provisioning of the product and service to the installed base of customers would stop or
deteriorate quickly.
Hosting costs should also include all core communication costs and depreciation on any owned assets. Customer/technical
support and customer success should include the salary and other direct costs of the CS team that is primarily focused on
retention. If a major portion of the CS team's effort is on upselling and cross-selling, those costs should be shifted to sales.
The salaries of the team responsible for keeping the production instance of the software up and running should also be
included in COS. All other R&D expenses should not be in COS.
BENCHMARKS AND DEFINITIONS: COGS
Cost of Goods
Jan
Feb
Mar
Hosting Expenses
$8,750
$9,000
$9,625
Internal Engineering Support
$4,100
$4,300
$4,000
Customer Support
$12,300
$14,000
$14,500
Third Party and/or Transaction Fees
$3,500
$3,600
$3,850
Professional Services
$32,000
$30,000
$35,000
Total CoGS
$60,650
$60,900
$66,975
www.saas-capital.com
COGS
PAGE 2
ABOUT SAAS CAPITAL
SaaS Capital is the leading provider of long-term Committed Credit Facilities to SaaS
companies. Focusing exclusively on the SaaS business model, SaaS Capital delivers faster
decisions, more capital, and longer commitments. SaaS businesses have used SaaS Capital's
Committed Credit Facilities, instead of equity, to finance growth and create hundreds of
millions of dollars in enterprise value without sacrificing significant ownership or control.
Also, through its partnership with DH Capital, a boutique investment banking advisory firm,
SaaS Capital can assist with M&A and capital raising services. SaaS Capital has offices in
Cincinnati, New York, and Seattle.
Visit www.saas-capital.com to learn more.
810 SEVENTH AVENUE, SUITE 2005 | NEW YORK, NY 10019
1225 HAYWARD AVENUE | CINCINNATI, OH 45208
7900 E GREENLAKE DRIVE NE, SUITE 206 | SEATTLE, WA 98103
IWWW.SAAS-CAPITAL.COM
TODD GARDNER | FOUNDER AND MANAGING DIRECTOR | TGARDNER@SAAS-CAPITAL.COM | 513-368-4814
ROB BELCHER | MANAGING DIRECTOR | RBELCHER@SAAS-CAPITAL.COM | 303-870-9529
The above definition is most consistent with what we see day-to-day and provides management with a solid view of the
company's contribution margin. Management can then decide how to invest that contribution margin back into sales,
marketing and product development on a discretionary basis.
Things not to be included in COS that we sometimes see included are:
1. Sales commissions
2. Amortized software development costs (we discourage capitalizing these costs in the first place)
3. Product management costs
4. Customer success costs focused on cross-selling or upselling
We also discourage the allocation of other overhead costs into COS. These are not direct variable costs, and allocation
processes are time consuming and generally inaccurate.
The core gross margin on SaaS license revenue is an important metric for all SaaS businesses. Gross margins on SaaS license
revenue for companies in our portfolio and our survey data of over 700 private SaaS companies, as defined above, are
generally 80% to 85%. Lower gross margin businesses might do very well, but they are fundamentally different in the way
they are valued and operated.
For more on SaaS accounting best practices, please see: What Should a SaaS Income Statement Look Like?