Calculating COGS for a Software Company: Support Costs

Editor’s Note: This is the sixth post in a series that combines to compose a best practices process on calculating the Cost of Goods or Services Sold (COGS or COS) for a software company. While this series is not meant to be an authoritative guide to all GAAP principles that should be followed when accounting for COGS, it will help a company figure out its COGS and gross profit by product line, geography, etc. This will be especially helpful to companies looking to raise expansion capital, as many venture capital firms ask for this type of information during due diligence. Ideally, it will also allow expansion stage software companies to optimize their sales and marketing spend by investing more resources into more profitable geographies and lines of business.

In the last couple of posts, I covered two different methods for calculating depreciation. In this post, we move on to the third COGS category: support costs (the first was material costs and the second was subscription and hosting costs).

Almost all software companies offer some kind of support to their customers. Most SaaS companies bundle a certain level of support with subscriptions, while perpetual license software companies either offer free support or sell it as part of “maintenance.” Some enterprise software companies offer a few different levels of support, and charge subscriptions to each (or at least the higher levels). Regardless of how a software company offers support, support costs is an important category in a software company’s COGS, and a category that is often mistakenly placed under a company’s operating expenses. That being said, the following is a brief overview of the most common support cost line items:

• Support salaries: This line item captures the salary and benefits expenses of a company’s support employees.

• Depreciation of equipment related to providing support: All of the equipment related to providing support that a company buys must be depreciated and added into this line item (this includes, but is not limited to, desks, chairs, computers, phones, headsets, etc. that are bought for support reps and employees). The company can use a number of different methods to calculate the depreciation of this equipment, two of which were described in detail in the previous two posts of this series.

• Leases of equipment related to providing support: All of the leased equipment related to providing support will have a periodic lease expense that should be added into this line item.

• Amortization of software related to providing support: Most companies will provide their support reps with software to facilitate the provision of support to customers (such as Microsoft Office, web-based support/help desk software, etc.). For the software that a company subscribes to, the periodic expense is simple to calculate (for example, if the company pays $1,000 per month for online help desk software, its annual cost will be $12,000). On the other hand, if the company buys a perpetual license for software that is related to providing support, the company needs to estimate the useful life of the software license (typically between 12 – 60 months), and amortize accordingly.

• Allocated overhead: Since a company’s support representatives typically sit in an office, the company needs to allocate overhead (such as rent, utilities, travel costs, etc.), for those employees.

Ready for more? Read the seventh and final post here.