What it means
Cost of revenue is what it costs to deliver the product or service customers pay for. Companies that sell physical goods call it cost of goods sold, or COGS. For a software company, it's the cost of keeping the service running for paying customers and supporting them while they use it.
For SaaS that usually means hosting for the live product, third-party software built into the product, payment processing fees and the customer support team. Engineers building new features usually sit in research and development, and sales and marketing stay in operating expenses.
GAAP doesn't hand you a list for SaaS. It's a policy you write down and apply the same way every month, so that a change in gross margin reflects a change in the business. On the P&L, revenue minus cost of revenue is gross profit, and operating expenses come below it.
Acme's payroll tool booked $9,000 of March support salaries to general and administrative salaries. Acme's policy puts support in cost of revenue, so the accountant moves it. Total expenses and the net loss don't change. Gross profit falls by $9,000 and operating expenses fall by $9,000. On $100,000 of monthly revenue, that's 9 points off gross margin.
Gross margin is computed straight from this line, which is why diligence teams test the split. Hosting parked in operating expenses is the item they move back most often.
Why it matters. Gross margin is revenue less cost of revenue, and investors value a business partly on it. Put hosting in operating expenses and your gross margin looks better than it is, until diligence moves it back.
The entry, worked
Acme's payroll tool booked $9,000 of March support-team salaries to general and administrative salaries. Acme's policy puts customer support in cost of revenue.
| Account | Debit | Credit |
|---|---|---|
| Cost of revenue: support salaries | $9,000.00 | |
| G&A salaries | $9,000.00 | |
| Total | $9,000.00 | $9,000.00 |
Total expenses don't change; gross profit falls by $9,000 and operating expenses fall by the same amount.
Common questions
Does GAAP say exactly what goes in cost of revenue for SaaS?
No. It's a classification you decide and apply consistently. Investors compare against common practice, so a written policy that follows it saves an argument later.
Do development and staging environments count as hosting in cost of revenue?
Usually not. Infrastructure that serves paying customers goes to cost of revenue; environments used to build the product generally sit in research and development.
Does amortization of capitalized software go in cost of revenue?
Often, yes. Amortization of capitalized software that delivers the hosted service is commonly shown in cost of revenue; amortization of internal tools usually isn't. Pick one policy and disclose it.
Where it comes up
The glossary entries, founder guides and lessons on this site that use the term and link here.
- Gross profitNet revenue less cost of revenue, as an amountGlossary
- How to reconcile Stripe payouts to your booksA Stripe payout is charges less fees, refunds and disputes, batched across days. How to book it gross, tie it to the bank, and keep revenue right.Guide · 4 min
- How to read an income statement (P&L)Revenue, cost of revenue, gross margin, operating expenses and net income, read line by line, on accrual basis, with the mistakes founders make most.Guide · 7 min
- Chart of accounts for startups: a starting templateA starting chart of accounts for a US startup: number ranges, the expense accounts you need, and when to add an account versus a class or tracking tag.Guide · 6 min
- The income statementTwo of the five account types, arranged so each subtotal answers a different question about how the month went.Lesson 10
- Closing the monthStatements are not the end. The close proves every balance against something outside the ledger, then locks the period so the numbers can't quietly change.Lesson 13
Read further
General information for US companies, not tax, legal or accounting advice. Check the specifics with a CPA before you act on them.