Financial Glossary
Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) represents the direct costs attributable to producing the goods sold or services delivered during a period. For product companies, COGS includes raw materials, direct labor involved in manufacturing, and manufacturing overhead. For SaaS businesses, COGS typically includes hosting and infrastructure costs, third-party software licensing embedded in the product, and customer support salaries directly tied to service delivery. COGS is subtracted from revenue to produce gross profit; the resulting gross margin percentage indicates how much of each revenue dollar remains after covering direct production costs, before general and administrative or sales and marketing expenses.
Problem & Application
A SaaS company billing $2M in annual recurring revenue incurs COGS of $600,000, comprising $300,000 in cloud infrastructure, $180,000 for a three-person customer support team, and $120,000 in third-party API costs embedded in the product. Gross profit is $1.4M and gross margin is 70%. Industry benchmarks for SaaS gross margins typically range from 65% to 80% for well-scaled products, so this company is within range. If the company negotiates a lower-cost cloud infrastructure contract and reduces infrastructure cost by $80,000, gross margin improves to 74%, adding $80,000 to gross profit annually. At a 10x ARR valuation multiple, that margin improvement translates to $800,000 in additional enterprise value. For a campground store or marina operation, COGS is more traditional: cost of merchandise, fuel, and bait sold in the season, which needs to be tracked separately from the service-side revenue (site rentals, slip fees) that carries much lower direct costs.
In Short
Monitoring COGS is essential for profitability. Companies should implement cost-saving strategies to improve gross margins and financial performance.