What is Cost of Sales (COGS) in a Startup?
Revenue on its own only tells half the story. To understand how profitable your product actually is, you must calculate the Cost of Sales (often referred to as COGS - Cost of Goods Sold). These are the direct costs that are intrinsically tied to delivering your product or subscription. For a SaaS startup, this typically means cloud infrastructure, database hosting, third-party software licenses, and direct customer support.
By subtracting your Cost of Sales from your total revenue, you arrive at your Gross Profit. The percentage of revenue you keep after these direct costs is your Gross Margin.
How Do You Accurately Model Cost of Sales?
An investor-ready financial model maps specific costs directly to the revenue streams they support. This prevents your model from treating direct costs as arbitrary overhead and ensures you calculate an accurate gross margin per product tier.
When adding a new direct cost, such as cloud infrastructure (e.g., Microsoft Azure), you must answer three critical questions:
- Which revenue stream does this cost belong to? Assigning it directly to a specific tier (e.g., "Basic Subscription") links the cost to the revenue it generates.
- What is the Cost Type? This determines how the model scales the expense. Does this cost trigger per signup, per user, or per paying customer?
- Does the cost increase over time? Setting an annual inflation rate or percentage increase allows you to realistically project future margins.
The Difference Between "Per User" and "Per Paying Customer"
This is one of the most critical decisions when modeling SaaS expenses:
- Per Paying Customer: Use this when a cost is only incurred when a user actively pays for a subscription (e.g., spinning up a dedicated premium server only for paid tiers).
- Per User: Use this when the cost applies to every single person in your system, regardless of whether they are on a free tier or a paid tier (e.g., base database storage costs that scale with total account volume).
Getting this allocation wrong will drastically overstate or understate your gross margins, which is a major red flag during investor due diligence.
How Does COGS Affect the Summary Dashboard?
A fully integrated financial model eliminates the need to manually update spreadsheets. When you attach a £3/month infrastructure cost to a £23/month subscription, the model instantly calculates a gross margin of roughly 87%.
Crucially, this data flows immediately into your central Summary Dashboard. Your overall net burn rate and runway automatically recalculate to reflect these new, scaling direct costs. By utilizing the "Customize Metrics" view on your dashboard, you can display "Cost of Revenue" and "Gross Profit" side-by-side with your total revenue, giving investors a transparent, month-by-month view of what the business actually earns after delivering the product.
Frequently Asked Questions (FAQ)
What is a good Gross Margin for a SaaS startup?
While it varies by industry, a healthy software-as-a-service (SaaS) business typically aims for a gross margin between 70% and 90%. Anything lower suggests disproportionately high delivery costs.
Are salaries included in Cost of Sales?
Generally, no. Core team salaries are usually classified under Operational Expenses (OpEx). However, direct customer success staff or implementation specialists dedicated entirely to product delivery might be factored into COGS.
Why not group all software costs under general expenses?
Grouping direct delivery costs (like AWS hosting) with general administrative software (like Slack or Notion) distorts your gross margin. Investors need to clearly distinguish between the cost to run the business and the cost to deliver the product.