Your Gross Margin Is Probably Overstated

I reclassified COGS for a SaaS company last month. Gross margin dropped nine points before I touched a single revenue line.

Not fraud. Nothing was hidden. The bookkeeper had been putting customer success salaries in G&A because "they're not building the product." Hosting costs were under IT. Payment processing fees were in banking fees. Each decision made sense in isolation. Together, they overstated gross margin by nine points.

What belongs in COGS

For a software company, COGS captures everything it costs to deliver the product to a customer who has already signed. Hosting and infrastructure. Payment processing. Customer onboarding and implementation. Support staff time spent resolving issues, not selling. Third-party API costs that scale with usage.

If you doubled your customer count tomorrow, every one of those lines would increase. That's the test.

G&A is overhead that doesn't scale with delivery. Your office lease, your CFO, your HR coordinator. These exist whether you add 10 customers or 100. S&M exists to acquire customers, not deliver to them. R&D builds what customers use but is typically expensed separately.

The line gets blurry. A customer success manager doing half onboarding and half expansion selling probably splits between COGS and S&M. An intentional allocation is fine. Leaving costs wherever they first landed when you hired someone is not.

Where the misbookings pile up

Customer success in G&A is the biggest single miss. Onboarding, implementation, and ongoing support belong in COGS. Selling renewals and expansions belongs in S&M. Most CS teams do both. Most are booked entirely in G&A because no one wanted to have the conversation.

Cloud hosting under "IT" is a close second. Infrastructure serving customers is COGS. Internal tooling and corporate IT is G&A. Often these are the same AWS account, split by no one.

Payment processing belongs in COGS. Stripe fees at $5M GMV run about $145,000 a year. Push to $10M GMV and you're at $290,000. That scales directly with revenue. It doesn't belong in bank fees.

The gross margin in your board deck is probably 5-10 points higher than the real number. That gap isn't decimal noise. It's the difference between a pricing model that works and one that slowly doesn't.

Why it matters

Gross margin shapes almost every significant decision in a growing company.

If you think you're at 72% gross margin and you're actually at 63%, your pricing model has phantom headroom. You can't discount as freely. Your economics on low-ACV customers are worse than you think. Hiring three more engineers sounds affordable until you reclassify the cost base those engineers will partially increase.

In a funding process, sophisticated investors normalize COGS anyway. Walking into a data room with a gross margin that reclassifies significantly is a credibility problem, even if the underlying business is strong.

Fix the classification now. One reclassification pass in your chart of accounts, applied consistently going forward. You won't like the new number. It's still the right one.