How to Categorize Expenses i

If you are a SaaS business owner, you must read this article to know:

  • How to Categorize Expenses in a SaaS Business?
  • What are the different heads under which the SaaS expenses are categorized?
  • What are the components of SaaS expenses?
  • Factors you must consider while categorizing these expenses

SaaS expenses are the costs you incur to run your Saas business and generate sales. Categorizing expenses into appropriate categories is important. This is because it gives you a clear view of how much are you spending and on what? Likewise, correct expense categorization also helps in calculating accurate SaaS metrics and undertaking correct forecasting. 

One thing you must understand here is that categorizing expenses accurately is the basis of forecasting and determining key metrics. And many of the SaaS companies aren’t able to do that correctly. And that’s where they suffer during tax filing, forecasting, and calculating key metrics. 

You incur an expense each time you advertise, pay salaries, buy office supplies, etc. By appropriately categorizing these expenses under various heads, you can create accurate budgets, pay the right amount of taxes, and even identify opportunities where you can save money. 

This article will help you understand how to categorize expenses in a SaaS business. You can easily identify if you are categorizing expenses correctly. Or you need to redo the categorization for accurate forecasting and calculating key metrics. 

Accordingly, the SaaS expenses are categorized under four different heads. These include:

  • Cost of Revenue, Cost of Goods Sold, or Cost of Services
  • Research and Development (R&D) or Engineering 
  • Sales and Marketing
  • Administrative Expenses

Let’s have a look at each of them in detail. 

I. Cost of Revenue 

Cost of Revenue, also known as cost of sales, cost of services, or Cost of Goods Sold (COGS) refers to the direct expenses for delivering services to customers in the case of SaaS companies. Accordingly, for your SaaS business, this is how you can categorize expenses related to the cost of goods sold: 

  • Hosting and Monitoring Costs

These include all the costs that you incur to run your software application online and deliver it to customers. This includes website hosting cost, cost of any third-party software, maintenance cost, etc. 

Basically, this is the cost that you incur to help customers access or download your product. It may also include the cost of hosting your website so that customers can sign up and buy your SaaS product. 

  • Payroll for Support 

This includes the salaries you pay to your staff engaged in customer or technical support. Say you have a SaaS application that needs training and requires you to send your trained staff to the client location. 

Similarly, you may have to send trained staff for integrating your SaaS application with the client website. Thus, the payroll of client support staff forms part of COGS. 

  • Cost of Developer Operations

Be careful when you are taking the developer cost into consideration while calculating COGS for your SaaS business. This does not include the cost of developing the software application. However, once up and running, the software may need improvements that will be made while the application is live and in use by your customers. 

  • Software and Tools 

This includes the cost of software and tools that your team may need for the seamless delivery of your SaaS product. For instance, software for security, chatbots, etc. 

  • Merchant Fees 

This includes the credit card processing fees. However, it is still argued whether it should be part of operating exp[ense or COGS for SaaS companies.  

Thus, the Cost of Revenue or COGS must include all those costs without which your SaaS business cannot deliver SaaS products. Additionally, it is important to monitor your SaaS COGS against the price of the SaaS application and your operating cost. 

This is because higher COGS against the revenue may impact your gross margin. COGS tells you how effectively are you able to generate returns given such a cost. 

II. Research and Development (R&D) Cost 

R&D cost is the cost incurred on developing, maintaining, and upgrading the SaaS product. This is the cost you pay to the developers and engineers for not only developing the product. However, you pay them for collecting data, evaluating it, and coming up with new features and solutions to solve challenges faced by your company in software, processes, etc. 

Being a technology company, you need to have in place a concrete research and development strategy. This is because it will help you to come up with better SaaS products ahead of the competition at the best prices. 

Now, you may either choose to spend incur R&D costs to improvise your current SaaS offerings, introduce additional features in them, or simply maintain them. 

If not the existing SaaS products, you can spend R&D costs on coming out with new offerings that can be launched into completely different markets. 

Given the importance of R&D, you may wonder what is the appropriate R&D spend that you as a SaaS company can incur? 

Research and Development Spending in SaaS Companies 

Blossom Street Ventures, a venture capitalist firm, undertook a study where it analyzed 90 publicly traded SaaS companies. These companies were studied both at the time of IPO and two years before the IPO launch. The aim was to understand how much did growing and successful SaaS businesses spend on research and development. Here’s the snapshot of the data collected by the company for various SaaS companies. 

How To Categorize Expenses
Image Source: Blossom Street Ventures

As per the data above, it is evident that SaaS companies spend close to 23% of their revenue on research and development. This is both at the time of IPO and 2 years prior to its launch. 

III. Sales and Marketing Cost

Sales and marketing cost is the expense you incur to make your SaaS offerings visible to boost sales and revenue. It is the cost you incur to make your product reach the right target market at the right time and in the right way. 

Concrete marketing efforts are an important part of beating the competition and being a  successful SaaS provider. Yet, many SaaS providers are unsure of how much to spend on sales and marketing and how to categorize expenses. 

This is because they are not very clear with what marketing and sales channels to invest in or are all about the SaaS product. As a result, they end up investing less in marketing and thus experience insignificant growth. 

This gives an advantage to their competitors who make an optimal investment in marketing and sales to get new users. If we consider the B2B SaaS providers, customers are highly likely to stick to the product instead of replacing it with the competition. This is because the cost of shifting to another Saas provider is higher than the cost of sticking to the same provider. 

For instance, if you’re already using Trello for project management for your team, just consider the hassle of shifting to another project management tool like Asana.  

Therefore, you as a SaaS need more customers for increased recurring revenue and not lose them to your competition. 

Some of the key channels whereB2B SaaS companies typically invest are as follows: 

  • Thought leadership SEO
  • E-mail marketing
  • PR
  • Social media channels like LinkedIn ads and LinkedIn organic
  • Trade shows 
  • Webinars 
  • Outdoor ads
  • Basic SEO 

Factors You Must Consider for Creating a B2B SaaS Marketing Budget

The following are the things you must consider while planning your B2B SaaS marketing budget: 

1. Marketing Channels With Highest Returns 

This requires you as a SaaS provider to look for marketing channels that work best for your industry. For instance, thought leadership SEO works best for SaaS companies and generates the highest returns. Establishing yourself as a company by publishing regular, high-quality content related to your SaaS offering can generate high-quality leads for your company. 

It would require you to come up with content that expresses stronger opinions that are backed by data. 

2. Time and Effort Needed to Get Potential Returns From the Channel

Here, you need to consider the time period for which you will have to keep making efforts towards a particular marketing channel to get the full potential from the channel. 

That is the effort and time needed to attain full potential with regards to lead generation from taht channel. 

3. Incidental Benefits Linked to the Marketing Channel

These are the benefits apart from the primary benefits that you would receive by investing in a particular marketing channel. 

For example, your increasing domain authority on Google may also give a boost to your PR efforts. Likewise, publishing constantly on LinkedIn may increase target market engagement. They may put valuable information in comments in the form of doubts or queries which can become your webinar topics. 

IV. General and Administrative (G&A) Overheads

 The general and administrative expenses are the overhead expenses your SaaS company incurs to run its routine business operations. 

Some of the examples of SaaS general and administrative expenses are as follows: 

  • Internet bill
  • Utilities
  • Office rent
  • Professional services like consulting, legal, etc
  • Expenses with regards to office supplies
  • Insurance 
  • Travel, etc 

Further, there are certain G&A expenses that are of fixed nature. That is these expenses will be incurred even if your SaaS company doesn’t sell at all. These include expenses like rent, electricity, which have to be incurred even if there are no new clients. 

Likewise, there are certain semi- variable G&A expenses that change with the changing requirements. For instance, you may need certain services like legal and professional at some point in time. 

Therefore, you may higher agencies for the same to whom you will make payments. However, you may stop taking their services once your work is done. 

On the whole, SaaS companies have a higher G&A as compared to traditional software companies.  This is because SaaS companies need continuous improvement in their systems. Also, SaaS companies see consistent growth which results in a relatively higher G&A. 

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