SaaS COGS Calculation and How to Use It to Grow Your Startup

Team Digits

Published February 24, 2025

Launching and growing a startup comes with its own set of struggles, many of which can be resolved with fundraising. Yet, to attract the right investors, you’ve got to have a handle on your business’ financials.

Understanding your profit and loss statement and balance sheet isn’t enough. Nor is occasionally looking at your bank statement. You’ve got to go deeper, and that includes getting to know your cost of goods sold (COGS).

In this guide, we’ll walk you through what COGS is, why your startup should be calculating it, and how exactly to go about doing that. This way, you can use your COGS calculation to help you manage expenses, increase revenue, and attract investors.

What is COGS (cost of goods sold)?

Cost of goods sold (COGS) is a metric that tracks what it actually costs to deliver your product or service.

For physical products, COGS will include everything you use to create your product, like the cost of raw materials and the machines used in the production process. For instance, if you produce tables, the cost of the wood, screws, and glue would all be part of your COGS.

But what does the cost of goods sold look like if your product is intangible, like software?

SaaS COGS includes any costs directly related to creating and updating the software you sell. This could include:

• Cloud hosting
• Software licensing
• Data storage
• Software engineers

SaaS COGS doesn’t include overhead, marketing, or admin costs — all the stuff that keeps the business running but isn’t directly tied to delivering your service. These other items may be tax deductible, but they shouldn’t be included in your COGS formula.

Why SaaS startups should care about COGS

The COGS calculation is important for SaaS startups specifically because it helps you spot inefficiencies, fine-tune pricing, and make smarter financial decisions — all of which can help you focus your resources where they’ll matter the most.

Here are a few reasons why knowing your COGS can help your startup:

• Uncovers cost drains: Your COGS calculation reveals where your money is going. If expenses are creeping up, you’ll know exactly where to cut back — without gutting essential operations.
• Improves cost efficiency: A high COGS can squeeze your profits, but it also presents opportunities to streamline. You might swap expensive full-time hires for freelancers or lock in annual software deals to lower costs.
• Appeals to investors: Investors care about your gross margin — the revenue left after paying COGS. Maintaining a gross margin of 75-90% indicates profitability and scalability, making your business more attractive to investors.
• Sets pricing with purpose: If you're a startup, understanding your COGS will help you set a pricing structure that ensures a reasonable profit margin.
• Tax benefits: A higher COGS means lower taxable income, which can reduce your tax liability.

Calculating your startup’s COGS isn’t a one-and-done, though. It’s a key part of accurately analyzing your financials, and it’s something you’ll want to do monthly. Use it to evaluate your company’s financial efficiency and cost management, and your startup will break even faster.

What are the key components of SaaS COGS?

A SaaS startup’s COGS looks very different from a company that produces physical products. SaaS COGS will include expenses like cloud hosting, labor, software maintenance, customer support, and payment processing fees.

Here’s a closer look at all of the things your SaaS company should include in their COGS calculation.

Cloud hosting and infrastructure

Cloud hosting and infrastructure keep your SaaS business scalable, efficient, and cost-effective. With the right setup, you get better performance (thanks to load balancing and automation), lower costs, and the flexibility to work from anywhere.

What you should include in your COGS:

• Subscription fees for servers, monitoring software, databases, and storage (AWS, Google Cloud, Azure)
• Content delivery networks (Cloudflare CDN, Amazon CloudFront)

To keep costs down, assess usage and choose the appropriate tier of service without paying more than you need. Also, find a provider that can scale to meet your needs.

Cybersecurity services and compliance costs

Keeping customer data safe isn’t just a best practice — it’s a business necessity. Cybersecurity services and compliance costs are direct expenses that protect your business from breaches, fines, and lost trust.

Whether you're defending against hackers or ensuring compliance with GDPR, SOC 2, HIPAA, or other industry regulations, you need the right infrastructure in place.

What you should include in your COGS:

• Compliance audits and certifications
• Security software and tools
• Legal and consulting fees
• Employee training programs

Failing to meet these standards can result in legal penalties, reputational damage, and loss of customer confidence, making compliance a critical investment for any business.

Software development and maintenance

You wouldn’t have software to sell without the employees who build and maintain it. Their work keeps your platform running smoothly, securely, and competitively.

What you should include in your COGS:

• Development
• Maintenance
• Updates
• Bug fixes
• Security patches
• System optimizations

Third-party software and API costs

Third-party software and APIs power your SaaS product by taking care of complex functions so you don’t have to. They can automate workflows, integrate seamlessly with existing tools, and save you months (or years) of development time by eliminating the need to build everything from scratch.

What you should include in your COGS:

• Licensing fees
• API usage fees for payment gateways
• Payment processing fees
• AI tools
• Data analytics tools
• Helpdesk tools
• Chatbots
• Automated support systems

Since these tools are integral to delivering products and services, their costs are directly tied to the cost of goods sold, impacting overall profitability and pricing strategies.

How to calculate SaaS COGS

Calculating COGS isn’t complicated once you understand your inputs. Plus, it gives you a clear view of profitability trends and cash flow management. Complete this monthly to stay on top of your key financials.

Step 1: Identify your direct costs

Look at the direct costs associated with creating your software, such as:

• Cloud hosting and infrastructure
• Direct labor costs
• Software maintenance
• Third-party software and APIs
• Customer support tech
• Payment processing fees
• Security and compliance
• Data storage and bandwidth

Find each of these expenses in your bookkeeping software or by looking at your startup’s bank statement. Many of these costs will be recurring, which makes it easy (if tedious) to update your COGS calculation over time.

The cost of goods sold formula is simple: Add up all these direct expenses. That’s it!

Here’s an example:

The total direct cost of producing the software is $19,000. Therefore, your cost of goods sold is $19,000.

Step 2: Calculate your gross margin

Now, use your cost of goods sold formula to figure out your gross margin. Your gross margin is an indicator of how much money you have to reinvest in the company. Calculate it by subtracting COGS from revenue and then dividing it by revenue.

Let’s say your revenue last month was $100,000. We’ll use the COGS from above of $19,000.

(100,000 - 19,000) / 100,000

With this calculation, your gross margin would be .81, or 81%. Remember that investors like to see a gross margin of 75-90%.

Step 3: Monitor and optimize

If your actual gross margin is a lot lower than the example above, you’ll want to figure out how to either lower your direct costs and/or increase pricing.

Be careful with pricing: Raising prices too much, too fast may cause customers to look elsewhere for a lower price. If your prices are much higher than the competition, you risk not attracting new customers. Consider raising prices once a year or only for new customers.

To lower your direct costs, look at what you’re spending money on and find ways to optimize what you’re using. For example, if you’re paying for more cloud storage than you’re using, drop down to a more affordable subscription tier. You can also automate some customer support functions with a chatbot to lower labor costs. And you may be able to negotiate API and software licenses for better pricing. It never hurts to ask!

Another thing to look out for is your COGS getting out of control as you scale. If your costs are eating too much into revenue, profitability will suffer — even if sales are growing.

Unlike traditional businesses where COGS scales with sales, SaaS COGS is more fixed, but not entirely. Some costs increase as your customer base grows, and managing them efficiently is key to maintaining strong margins.

Here’s what to watch:

• Cloud hosting and infrastructure: More users mean higher AWS or Google Cloud costs. Optimize storage and compute usage so you’re not paying for unnecessary capacity.
• Third-party APIs: Many integrations charge per request or user. Keep an eye on usage-based fees and ensure your pricing accounts for these costs.
• Customer support and success: A growing user base often means hiring more support staff or investing in automation to keep service levels high.
• Payment processing fees: If you charge customers via Stripe or PayPal, these fees scale with revenue. Factor them into your pricing strategy.

Keeping your COGS under control is key to maintaining profitability as your SaaS business scales. If your COGS is climbing faster than revenue, something’s off. Regularly tracking expenses against revenue growth ensures you’re not letting costs spiral out of control.

Common mistakes in SaaS COGS calculation

Startups often make errors with COGS calculations by including the wrong expenses or not including the right ones.

It’s easy to overlook expenses that are directly involved in producing software, such as:

• Customer support labor and tools
• DevOps expenses
• Third-party API costs
• Payment processing fees

Another mistake startups make is misclassifying operating expenses as cost of goods sold. Remember that COGS only includes the costs directly related to producing the product you sell.

Reviewing COGS only once a year or less is another common error. Using an outdated number can result in having a skewed view of your startup’s profitability and cash flow. Monitor COGS monthly and find ways to reduce costs to keep it down.

And finally, realize that your COGS should grow slower than revenue growth as your company scales to improve profitability and operational efficiency. If COGS scales too quickly (e.g., rising infrastructure costs per user), your startup’s revenues will suffer. Without additional money to reinvest in your business, you may struggle to find customers. If, for example, you lack the budget to invest in marketing, how will you attract new business?

How to use COGS insights to drive growth

Knowing your COGS is a powerful tool for driving growth, profitability, and scalability in your SaaS business. Here’s how to leverage COGS insights effectively.

Improve your bottom line

Your gross margin impacts how fast your startup can scale. A higher gross margin means you have more money to invest in sales, marketing, and product development. A lower gross margin may make it difficult to scale, given that you’ve got less money to reinvest in the company. This may turn off investors, who want assurance they’ll see a quick return on their investment.

If, after calculating your SaaS COGS and gross margin, you see that margins are low, find ways to improve your bottom line. Streamline operations by using technology, refining workflows, and eliminating bottlenecks. Increased efficiency helps reduce waste and improves profitability. Also focus on customer retention rather than attracting new customers, which costs more.

Examine and optimize expenses

Your SaaS COGS will show which expenses may be causing a higher burn rate for your startup. Maybe your cloud hosting costs have risen without you noticing. Or you’ve got too many engineers on the team for the amount of work to do.

Look at how you can reduce costs by changing services or companies. Renegotiate third-party software fees with vendors by signing up for a longer-term contract. Also, consider outsourcing non-core functions to freelancers or consultants rather than paying full-time salaries and benefits.

Review your expenses quarterly to ensure they are still necessary to keep your COGS down.

Make sure your startup is attractive to investors

Financing from investors can ensure you have enough runway to reach profitability. But to successfully fundraise, your startup’s finances must be attractive to investors.

Investors look at gross margin, operating expenses, and revenue to understand the potential return on investment your startup presents. If your COGS is too high, investors may question your startup’s potential for profitability since you have less money to reinvest in the company. Lowering a high COGS before pitching investors helps you maximize your chance of getting funded.

Simplify SaaS financial metrics with Digits

Are you running a SaaS startup? You need real-time accounting, forecasting, and financial reporting to stay on top of your burn rate, profitability, and revenue — without getting lost in spreadsheets.

With Digits, tracking COGS, gross margins, and other key financial metrics is effortless. Our AI-backed platform automatically categorizes transactions and calculates COGS for you — no manual number-crunching required. Just log in and see your financials live in real time on your customizable dashboard.

Ready to get the financial edge you need to scale? Let Digits handle the numbers so you can focus on growth. Book a demo with our team today.