The Cost of Goods Sold (COGS) is the total expenses associated with creating and delivering a product to customers. Traditionally, COGS is calculated using the Cost of Goods Sold formula:

Starting Inventory + Purchases - Ending Inventory = COGS

For SaaS and subscriptions, calculating COGS is a little different than with inventory-based businesses. Because software isn’t continually manufactured, acquired and delivered, the formula above doesn’t apply. 

Variables like subscription models, transaction fees and third-party support can all make COGS difficult for SaaS businesses to define. As a result, calculating COGS for software services is often complicated, and native ERP solutions can improve accuracy and line of sight for leaders by simplifying calculations and reporting.

Understanding expenses for SaaS & subscription services

For SaaS and subscription services, most COGS expenses involve delivery and implementation for customers. Items in your Cost of Goods Sold formula should include:

• Hosting. Site upkeep and personnel costs 
• Customer support. Onboarding, technical support and operational assistance related to customer satisfaction and retention  
• DevOps. Internal expenses to resolve bugs, improve customer experience, pay salaries and implement upgrades
• Transaction and third-party fees. Any costs associated with partners directly related to implementation and service   

Crucially, unlike inventory-based COGS, the Cost of Goods Sold formula for SaaS and subscription models does not include manufacturing or R&D. This number also shouldn’t roll in customer acquisition and related expenses. 

Calculating COGS for SaaS

Once you’ve identified the elements that contribute to your Cost of Goods Sold formula, add them up to find your COGS.

For example:

Hosting: $5600
Customer Support: $11,000
DevOps: $8300
Fees: $2400
---------------------
COGS: $27300

If your total monthly revenue is $175,000, you can divide your COGS ($27300) by this number to find your percentage of COGS to revenue (~15%). 

Subtract your percentage fo COGS revenue from 100% to find your gross profit margin (~85%). This is a very important metric that can be used by investors and leaders to evaluate the health of your business and growth strategy. 

Why tracking COGS matters

Tracking COGS for inventory-based businesses is a fundamental metric for measuring profitability, the health of supply chains and gauging position in the market. However, for SaaS and subscription companies, accurately tracking COGS with real-time data can have deeper business implications.

A healthy gross profit margin for an SaaS company is typically 70-80% because COGS is much lower than for inventory-based businesses. This contributes to the rapid growth and scaling across the industry that’s projected to reach $10 trillion by 2030. 

To keep pace, finance teams need to have access to data architecture that supports deep visibility and real-time reporting to leverage opportunities such as:

• Investments. VC firms will be closely scrutinizing growth% vs. profit% to determine the health of your business. 
• Acquisitions. Your ability to evaluate your growth-to-profit ratio quickly and accurately directly impacts how nimble and aggressive leaders can be.
• Better risk management. Real-time visibility into COGS allows finance teams to lead on strategy, anticipate cash flow, identify issues quickly and support other business functions. 
• Automation. Tools like native ERP integrations that unlock automated workflows across the business go hand-in-hand with optimized COGS calculations. 

How your ERP can support better COGS visibility

Third-party and hybrid integrations for ERPs often result in bottlenecks or incompatibilities between critical systems that require time and manual work to resolve. These issues result in old data filtering into key reports that rely on COGS calculations. That clouds decision-making, obscures emerging risk and pushes out timelines for evaluating the health of the business.

Native ERP solutions for billing and reporting allow finance leaders to centralize all their data and workflows in a single environment that’s purpose-built for calculating KPIs like COGS. Native integrations look and feel like your preferred ERP environment, and they extend its out-of-the-box capabilities to provide the following benefits for COGS calculations:

• Single source of truth. By housing all your data entirely within an ERP like NetSuite, every department can trust the numbers they’re working with. 
• Eliminating multiple logins. Because native integrations operate entirely within your ERP, finance teams won’t have to wrestle with juggling systems to get the data they need.
• Real-time visibility. Data doesn’t have to be reconciled with native ERP integrations and flows seamlessly between systems in real time. 
• Accuracy. Without spreadsheet creation spreading errors from system to system, native integrations deliver clean data streams directly to reporting tools like Power BI. 
• Investor confidence. Native integrations indicate a high degree of automation maturity, and the benefits they offer for COGS calculations extend to billing, revenue recognition, reporting and compliance. 

Get the clearest picture of your business with Zone

Developing a Cost of Goods Sold formula for your SaaS and subscription models is just one step in the process of creating a healthy business strategy that unlocks all your opportunities for growth. Zone & Co’s portfolio of native NetSuite SuiteApps can revolutionize your back office operations for unlimited growth and scaling potential.

• ZoneBilling supports complex billing models and ensures accurate revenue recognition all within NetSuite.
• ZoneReconcile automates cash reconciliation across banks, cards and PSPs inside NetSuite – faster closes, fewer errors, full visibility.
• ZoneReporting delivers auto-updated reports to stakeholders with Power BI dashboards based on industry best practices, tailored to your business and fully integrated with NetSuite.

To find out how Zone can revolutionize your NetSuite finance strategy, book a demo today or begin exploring by taking a self-guided tour of our products.