# COGS (Cost of Goods Sold)

## Quick Definition

The direct costs of producing and delivering your product or service, subtracted from revenue to calculate gross profit.

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## What is COGS?

Cost of Goods Sold (COGS) represents the direct costs of producing and delivering your product or service. For SaaS companies, this typically includes hosting, third-party software, and customer support costs.

COGS is subtracted from revenue to calculate gross profit. It excludes operating expenses like sales, marketing, and R&D, which come out of gross profit.

## SaaS COGS Components

- Cloud infrastructure (AWS, GCP, Azure)
- Third-party software and APIs integrated into the product
- Customer support and success teams directly serving customers
- DevOps and site reliability engineering
- Payment processing fees

## Why COGS Matters

COGS directly determines your gross margin, which is a key indicator of business model quality. High COGS means low margins and less money for growth. Optimizing COGS improves profitability without cutting investment.

## How to Calculate COGS Step by Step

**Step 1: List every direct cost of delivering your product.** The key question: "Would this cost go away if I had zero customers?" If yes, it's COGS.

**For SaaS:**
- Cloud hosting (AWS/GCP): $28,000
- Third-party APIs baked into product: $11,000
- Customer support team: $32,000
- DevOps/infrastructure team (portion): $18,000
- Payment processing fees: $9,500
- **SaaS COGS: $98,500**

**For Ecommerce:**
- Product/inventory cost: $150,000
- Shipping and freight: $38,000
- Packaging materials: $8,000
- Fulfillment labor: $22,000
- Payment processing: $9,500
- **Ecommerce COGS: $227,500**

**Step 2: Exclude operating expenses.** These are NOT COGS:
- Engineering/R&D salaries (except DevOps directly supporting production)
- Sales and marketing
- General and administrative
- Office rent
- Legal and accounting

**Step 3: Calculate gross profit.**
- Revenue: $500,000
- COGS: $98,500
- **Gross Profit: $401,500**
- **Gross Margin: 80.3%**

**Step 4: Set up proper cost categorization in your accounting.** The biggest challenge with COGS is consistent categorization. Set up your chart of accounts with a clear COGS section from day one. This prevents scrambling to recategorize expenses before an investor meeting or audit.

**Common mistakes founders make:**
- Putting all engineering salaries in COGS (only infrastructure/DevOps teams belong there)
- Excluding payment processing fees (Stripe's 2.9% is a real cost of delivery)
- Inconsistent categorization month to month (makes trend analysis useless)
- Not tracking COGS per customer (hard but valuable for understanding unit economics)

## COGS in Ecommerce

For ecommerce, COGS includes product cost, shipping, packaging, and fulfillment. Margins are much tighter than SaaS, making COGS optimization critical for profitability.

## Formula

Gross Profit = Revenue - COGS

Gross Margin % = (Revenue - COGS) ÷ Revenue × 100

## Example

SaaS COGS breakdown:
- Cloud hosting (AWS): $30,000
- Third-party APIs: $12,000
- Customer success team: $45,000
- DevOps/infrastructure team: $25,000

Total COGS = $112,000

If revenue is $500,000:
- Gross Profit = $388,000
- Gross Margin = 77.6%