Software companies struggle to accurately calculate the cost of goods sold, but we make the process simple. If you’re tired of calculating COGS the traditional, hard way, simply use our software for profitability modeling with its built-in cost of goods sold calculator.
Profit Frog takes an innovative approach to calculating COGS and to FP&A in general. We focus on what helps service businesses stay ahead of the curve. Our profitability modeling tools not only track expenses and revenue, but also enable you to predict future profits based on adjusting your various business drivers.
What is a software company?
Software companies are businesses that create software, software technology, software distribution, and software product development as their main products.
Products such as applications, games, and operating systems are developed and sold by software companies.
Types of software companies
There are three main types of software companies:
- Software product companies
- Software services companies
- Cloud-based software companies
What is cost of goods sold?
Cost of goods sold is a key metric on a financial statement. It measures the costs associated with the production or delivery of a product or service. Cost of goods sold is calculated differently for software companies than for other business models, such as manufacturers or service businesses. Let’s take a look at how COGS differs depending on the type of business.
COGS for manufacturers
Cost of goods sold, also known as cost of sales, refers to the direct expenses associated with the production of goods. They include direct labor and raw materials.
Generally accepted accounting principles (GAAP) define cost of goods sold as the general cost of producing items sold during a selected period.
Our COGS definition: every direct cost involved in manufacturing a product or delivering a service. We like this cost of goods sold definition because it includes service businesses.
COGS includes all expenses directly related to revenue production. If a company sells a physical product, for instance, the cost of goods sold will include transportation costs, direct material costs, and any other direct expenses.
These expenses should be included in COGS for manufacturers:
- Product transport costs
- Product storage costs
- Raw materials
- Tools and parts used in production
- Factory labor costs
COGS for software companies
Cost of goods sold for a software company is simply the cost of delivering its solution to its customers.
Because software companies have no “goods sold” most business owners will refer to this metric as cost of revenue.
Understanding COGS for software businesses is essential for accurate accounting and modeling.
Cost of goods sold for software businesses includes:
- Personnel costs for DevOps employees
- Cost of third-party software
- Personnel costs for the customer support team
- Personnel costs for the professional services team
- Hosting expenses to deliver the software
Cost of goods sold does not include marketing expenses, overhead expenses, or research and development costs.
Our software company forecasting software includes a handy cost of goods sold calculator to make COGS—and all other aspects of budgeting and forecasting—much easier.
COGS for service businesses
Calculating COGS for service businesses is different from calculating COGS for manufacturing businesses. COGS will include expenses involved in providing the service: direct labor, tools, and parts used, and transportation costs.
COGS for a SaaS company
Understanding SaaS COGS is important for steering your SaaS to optimal profitability. But SaaS businesses don’t make physical products; ergo, they don’t have “goods sold.” They still have COGS, except that they should probably be called “cost of services delivered.” We won’t hold our breath hoping “COSD” gets widespread adoption. Instead, we’ll keep on using “COGS.”
When sorting COGS and operating expenses in a SaaS, COGS are all the expenses directly related to delivering the software service. OPEX are all the overhead and administrative costs.
SaaS companies should include in COGS:
- Application hosting and monitoring costs
- Data communication expenses
- Software license fees
- Website development and support costs
- Subscription costs
- Hosting costs
COGS for SaaS companies do not include:
- Product management costs
- Sales commissions
- Customer success costs
- HR costs
- Office expenses
Calculating cost of goods sold with no inventory
For manufacturing businesses, calculating COGS is based on inventory tracking.
Since software companies don’t have inventory, most software businesses will find COGS calculations almost impossible with the traditional inventory-based cost of goods sold formula.
Profit Frog makes calculating COGS with no beginning inventory simple. Our COGS calculations are in real-time rather than doing retroactive inventory accounting after a calendar year (or quarter, or month) has closed. Our method gives small business owners proactivity and control, which is why the Profit Frog approach is essential.
Software company owners can get a current picture of their company’s health by putting all of their costs, including COGS, into their dashboard. There is no need to wait until the end of a fiscal period; they have real-time visibility into the true drivers of their business. Then, by changing variables and creating different scenarios, they can predict future COGS, OPEX, profit margins, and other things. This type of corporate forecasting is known as “scenario planning,” and it provides software companies with the competitive advantage they need to navigate a volatile environment.
With our tools, software company owners no longer have to worry about calculating costs, determining the correct cost of goods sold formula, or calculating OPEX. Simply follow our prompts to discover how quick and straightforward budgeting and forecasting for small businesses can be.
Traditional cost of goods sold formula for manufacturing businesses
COGS=beginning inventory+purchases during the period-ending inventory
- Beginning inventory: a business’s inventory at the beginning of an accounting period.
- Purchases: costs incurred to produce a good or service during an accounting period.
- Ending inventory: the inventory remaining at the end of an accounting period.
At the start of each year, any products that got sold in the previous year are removed from the beginning inventory. Once you calculate the total cost of the beginning inventory, as well as all purchases for the period; the resultant number will be subtracted from the sum of beginning inventory and purchases to give your cost of goods sold.
Let’s say your business had a beginning inventory value of $20,000. There are also $8,000 of costs (purchases), and you have $5,000 in inventory remaining; that gives a COGS of $23,000 for the accounting period.
With Profit Frog, there is no need for business owners to worry about calculating costs or finding the right formulas. Just follow our prompts and see how easy small business forecasting can be.
We give you a clear picture of your company’s COGS and show how you can increase profitability.
Calculate software companies’ cost of goods with this formula:
Total Revenue-Gross Margin=COGS
Cost Of Goods Sold Formula With Gross Profit
Gross profit is one indicator of a company’s efficiency. Gross profit is calculated by subtracting the cost of goods sold from your company’s total revenue.
The gross profit margin varies by industry, but it is commonly used to assess the profitability of a singular service. It will show how effectively you are utilizing resources to deliver your service.
Gross profit margin formula
(total revenue-COGS)/total revenuex100=gross profit margin
This formula indicates how successfully your business generates revenue while keeping the cost of goods sold low.
Rather than concentrating on gross profit, our customers benefit from maximizing net profit. After all expenses have been paid, the remaining amount is the net profit: COGS plus operating expenses (OPEX). You’re in business to maximize your net profit, and we can help you get there.
Software company gross margin
Gross margins for software companies usually fall in the range of 70% to 85%, which is why 75% is used as a benchmark.
Software company gross margin formula:
Gross margin=(total revenue–software COGS)/total revenue
See? It’s backward-looking. You can do a lot better.
What is the best cost of goods sold calculator?
Profit Frog helps you analyze and collect data for cases like seeing future or current products. Understanding COGS is crucial when planning for your software business. COGS calculators give you a clear picture of your costs, which lets you build the kind of business you want.
We assist you in calculating COGS by having you individually enter the following costs:
- Cost of hosting
- Cost of development
- Cost of technical maintenance
- Costs of services teams
This procedure will assist you in gaining an in-depth understanding of what goes into the production of each product or service. Ultimately, this will lead to a better understanding of your business and where your profit centers lie.
Our tools will allow you to dynamically model different costs and use them to forecast possible futures. Tools for scenario planning will help you adjust as conditions dynamically change.
If you use dynamic planning, you can get rid of guesswork and get rid of business plans that don’t work.
Software COGS FAQ
Are Saas companies the same as software companies?
SaaS companies are a subset of software companies, specifically those who sell their products on a subscription basis. Not all software companies are SaaS companies, but all SaaS companies are software companies.
Are COGS and OPEX the same?
While COGS is a business expense, it is not considered an operating expense. An operating expense is the cost incurred in daily operations, regardless of sales volume.
COGS and operating expenses are mutually exclusive. If an expense is COGS, it is not OPEX, and vice versa.
What are variable costs?
A company’s expenses consist of fixed and variable costs. Variable costs change in proportion to how much the company produces or sells. They fall when production decreases and rise when production increases.
Variable costs are viewed as short-term costs because they can be adjusted quickly. For example, if a business is having trouble with cash flow, it can take steps right away to slow down production or find other ways to cut variable costs.
Variable costs include direct labor costs, costs of raw materials, sales commissions, and some wages, which is why cost of goods sold is mostly made up of variable costs.
Is COGS an asset?
COGS is not an asset; it is an expense. Expenses are the cost of running a business; they are one of the five main accounts in accounting.
COGS is an expense account on an income statement, making it a debit. Because cost of goods sold is a debit, not an asset, it is a business factor that should be minimized to increase profitability.
Profit Frog’s main goal is to help software business owners make their businesses more profitable. It’s why we focus on profit modeling and dynamic planning.
Cost of revenue vs COGS: is there a difference?
No. Cost of revenue is just a different term for cost of goods sold.
What is annual recurring revenue?
Annual recurring revenue (ARR) is a term that refers to all ongoing revenue for a product or business that is projected to be generated over a year. Revenue (ARR) is used by companies that offer yearly subscriptions to determine how much recurring revenue they can expect each year.
What is a cohort analysis?
Cohort analysis is a type of behavioral analytics that groups data from a specific subset, such as a software company, game, or e-commerce platform, into related groups rather than viewing the data as a whole. The groupings are known as cohorts.
Where can I find COGS on my income statement?
You can find your company’s COGS on the income statement, below the revenue line.
What is included in OPEX?
Operating expenses are those costs necessary to sustain day-to-day operations, but which do not directly relate to delivering a service.
The main goal for many small businesses is to maximize gross sales relative to OPEX. By doing so, OPEX will represent the core measurement of a company’s efficiency.
The most common examples of operational expenses are:
- Business travel
- Property rates
- Wages and salaries
- Legal fees and accounting
- Interest paid on debt
- Administrative expenses
- Digital marketing
- Overhead costs
What are key SaaS metrics?
There are four key SaaS metrics that a company needs to track
- Customer lifetime value
- Customer acquisition cost (CAC)
- Annual recurring revenue (ARR)
- Monthly recurring revenue (MRR)
What is operational efficiency?
Operating efficiently means that your company is using its resources, equipment, inventory, and money in the most optimized way. Efficient companies are the most profitable and agile.
What is cost optimization?
Cost optimization is a discipline used to maximize the value of a company while reducing costs and reducing dependence.
Cost optimization includes rationalizing platforms, processes, applications, and services.
Can a customer story benefit my software company?
Yes, a positive customer story or case study is always a great asset to build social proof and credibility with your target customers. A positive testimonial quote for your clients will help with revenue growth.
How to calculate SaaS COGS?
This is the formula used to calculate SaaS COGS:
Total revenue-gross margin=COGS
What is a customer success strategy?
A customer success (CS) strategy is a business’s plan for engaging and helping customers in a proactive way throughout the customer lifecycle. CS strategy ensures customers get the most out of a business’s service or products so that they’re able to reach their goals without further product adoption.
What is cost per customer acquisition?
Customer acquisition cost (CAC) measures the cost to a company of acquiring a new customer. CAC is the total cost of sales and marketing to convince a customer to buy a product or service.
Why is revenue retention important?
Revenue retention is one of the key metrics for software and SaaS companies, as it measures how much revenue your business can generate from its current customer base.
What is a SaaS product?
SaaS products are internet software that is available to anyone who has an internet connection.
Here are some SaaS company examples:
What is cloud spend?
Cloud spend is the estimated amount spent on your business’s cloud infrastructure. Like an electricity bill, public cloud providers bill based on usage and meter costs based on how much usage is measured.
What is the use of due diligence?
The primary use of due diligence is to reduce exposure to risk. In business, doing “due diligence” means looking over financial records and performing other background research before moving forward with a deal with another party.
About Profit Frog
Profit Frog is the best software for small businesses to use for budgeting and forecasting, and it was made to be as simple as possible. Whereas other FP&A software solutions focus on complex forecasting of cash flows and other factors, Profit Frog simplifies forecasting to focus on the most important factor: profitability—rather than pure sales revenue. Our financial modeling software allows you to assess your business’s financial health, and look into the future to understand how all of your variables will affect future profitability as you adjust them. With this information, you’ll be able to map out a path to maximize your profits.