What should be included in COGS for my SaaS business?

Accounting rules are very specific on some things, and surprisingly unhelpful in other areas. There are no Generally Accepted Accounting Principles (GAAP) rules on the type of costs that are included in Cost of Goods Sold (COGS). 

This is unfortunate because the gross margins of SaaS businesses are very important to overall performance, profitability, and valuation.

Having analyzed over 1,000 SaaS company financial statements, SaaS Capital has pulled together our thoughts on the subject. Here is what we generally see included, and what we recommend.

Costs we recommend including in COGS:

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 any sales costs for up-sells, 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

Also included, but to be broken out separately:

6. Professional services costs (implementation or other)

Things we advise against including:

1. Sales commissions
2. Allocated overhead charges
3. Customer success costs associated with cross-selling/up-selling
4. Product development costs
5. Third-party software use in-house for operations, but not packaged in your product

We would also advise to keep it simple and avoid sophisticated chargebacks or allocations. Formulas for those costs are subject to review and change, and each change destroys historical trend-line data useful to the business.

If you structure your P&L as suggested above, you will be in-line with the majority of other private SaaS businesses. This will allow you, potential investors, or a possible future acquirer, to more quickly understand your business and benchmark your performance.

Source: https://www.saas-capital.com/blog/cogs-for-saas-business/