Defining Cost of Goods Sold

In goods manufacturing businesses, Cost of Goods Sold, or COGS, is the sum of all costs the company incurs to generate the associated revenues. In the example of a tire factory, this includes the materials used to create the tires, the labor/machine hours on the factory line, and, generally, some overhead costs allocated to the production of the tires. It does not include administrative/sales/office costs. Taking the price that the tires sell for (Revenues) less the cost they required to be created (COGS) generates the gross profit of the business.

Expand this idea to a SaaS company, and COGS changes dramatically. Now, COGS may more frequently be referred to as “cost of sales”, as there is generally no physical manufacturing involved in the process. Software and SaaS COGS are composed of things like:

1. Developer salaries (for platform-related activities, not R&D, etc.)

2. Some customer service costs

3. Web hosting

4. Wages for salespeople

When costs are more accurately classified as COGS, it is easier to assess the financial performance and forecast of a company. SaaS companies generally have very low COGS, as the main costs of the business should be incurred to develop the software. Selling it, in theory, should be the easy part.

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