Cloud computing has revolutionized the way businesses operate. It offers flexible, scalable, and cost-effective IT solutions. However, as businesses move their operations to the cloud, they need to pay close attention to their cost of goods sold (COGS). This metric is required to make sure they are achieving maximum profitability. COGS represents the direct costs associated with producing and delivering a product or service. It also includes the cost of cloud infrastructure, development costs, and other expenses as part of the cloud computing cost. Businesses that track this metric can understand their profitability better. Also, it helps to make informed decisions about pricing, resource allocation, cost optimization, and investment.
How to calculate COGS
Let’s say a SaaS company provides a project management tool to its customers. This company had $80,000 in allocated cloud infrastructure costs during a particular period. It includes the cost of servers, storage, and other cloud services used to deliver the app. Also, the company incurred $30,000 in other direct costs: salaries for developers and customer support.
Let’s look at COGS formula for a SaaS product. We can calculate the cost of producing and delivering the product for the period with all cloud costs included, as follows:
Allocated Cloud Infrastructure Cost + Other Direct Costs = Cost of Goods Sold
$80,000 + $30,000 = $110,000
So the cost of producing and delivering the project management tool for the period was $110,000. It includes the cost of cloud infrastructure and other direct expenses.
Cost of cloud computing in COGS
Let’s look at reasons why tracking COGS is important for businesses.
Understanding the Cost of Cloud Infrastructure
The cloud computing cost can become unpredictable. It happens because of the flexibility vendors offer to businesses to scale their IT infrastructure. Each company needs to track the cost of its resources to understand the direct costs associated with operating in the cloud. It helps in making informed decisions about resource allocation.
Optimizing Resource Utilization
Also tracking COGS can help to identify areas where the company can optimize its resource utilization. This includes identifying underutilized resources, monitoring resource usage, improving resource allocation, and results in insights for cost optimization.
Improving Pricing Strategies
COGS awareness can help businesses develop more effective pricing strategies. Companies need to monitor direct cloud costs associated with producing and delivering products or services. It allows them to set prices that cover their expenses and generate profit. Businesses can compete more effectively in the market and generate higher revenue.
Identifying Cost Savings
It is much easier to identify areas for potential cost savings while tracking COGS. It requires identifying inefficiencies, waste, and unnecessary expenses associated with cloud costs. By optimizing operations and reducing the cost of cloud computing, businesses can improve profitability and achieve long-term success.
Meeting Financial Reporting Requirements
Tracking COGS is also important for meeting financial reporting requirements. To calculate accurate financial statements, a company needs to track its direct costs and COGS. Both are necessary for gross profit, which is an important metric for investors, lenders, and other stakeholders.
In summary, tracking COGS in cloud computing is very important for businesses. It provides valuable insights into the direct costs associated with operating in the cloud. Also, it helps businesses to optimize their resource utilization, improve pricing strategies and achieve cost savings. Last but not least – it meets common financial reporting requirements. Moreover, while tracking COGS, businesses can enable cloud cost optimization to achieve higher profitability and compete more effectively in the market.
In our next articles, we’re going to find out what are the possible areas for reducing COGS and show you some of our real-life examples of achieving this goal.
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