This is Part Four in our Series, "Finance: Storytelling with Data" where we break down how to tell the story of your business using your own financial data. Get up to speed on the previous parts below:
Part Two: What Has My SaaS Business Achieved?
If you’ve been following along with our series, the next thing necessary to tell your financial story is understanding how much cash you have left after you deliver your product or service. (If you haven’t, we’re glad you’re here! Catch up on Parts One, Two, and Three for a little more context). This might seem like a much simpler question than we had last time—but it is just as important to understand.
Knowing the answer to this question is hugely important for your growth. The money you have left after delivering your product or service is the amount of money you can then invest back into your business to grow, or return back to owners as profits. You want to make sure you can deliver your revenue in a cost-efficient way, so that you have enough money left for these activities.
How do you find out what’s left over? You might have guessed it, but we first need to calculate our Cost of Goods Sold / Cost of Sales (COGS / COS). Cost of Goods Sold represents the direct costs of materials, people, software, etc. needed to deliver your product. Your COGS will vary based on the type of business you have and what you sell.
For example, if you sell pizza, your COGS will be the ingredients, the box, and the cost of the people you pay to make the pizza. This is rather clear. However, I often work with SaaS companies, and trying to figure out what costs directly relate to the delivery of their product or service isn’t as obvious. At a high level, a SaaS company’s COGS should include:
Want to read more? Check out our deep dive on COGS.
Once you figure out your COGS, it’s time to answer our question: how much is left? This is also known as your Gross Margin. Gross Margin is calculated as Revenue less COGS. Similar to how your COGS might vary by industry, a good Gross Margin as a percentage of revenue will also vary by industry.
As you can see above, SaaS gross margins trend higher than other industries. This means SaaS companies often have more money left to reinvest back into the business or return to owners—one of the many reasons the SaaS business model is attractive to many.
What do you do if your gross margin isn't in line with the industry benchmark? Don’t worry, you can always improve your gross margin. Simply put, you’ll need to focus on either increasing revenue or decreasing costs. I suggest starting by calculating the gross margin for each product line to see where you might need to focus your efforts.
Then, take a deep dive into your costs. Where can you scale back costs or find cheaper alternatives? Alternatively, do you have the ability to raise prices? Ask your current customers or other potential customers what they would be willing to pay for your product or service and check out your competitors’ prices to see how you compare.
When you fully understand how much money you have left after delivering your product or service, you have a better idea of the health of your company beyond just observing growth. Knowing just how much you have left to invest back into your business will power the engine allowing you to keep on growing, scaling, and achieving your goals.