When to Classify Costs as COGS vs Operating Expense, and Why It Matters
If you’re building or scaling a business, understanding how to classify your costs isn’t just a bookkeeping detail. It shapes how your financials are interpreted by investors, your board, and your team. A clear cost structure supports stronger decisions around pricing, margin targets, and operational planning.
Let’s break down what qualifies as Cost of Goods Sold (COGS), what falls under Operating Expenses (OpEx), and why this distinction matters.
What Is COGS?
COGS refers to the direct costs required to deliver your product or service. These are the expenses that scale with revenue.
Examples:
Hosting costs for a SaaS platform
Payment processing fees
Hardware fulfillment in a productized service
Implementation and onboarding labor
Customer support tied directly to product delivery
If no revenue is generated in a given month, most of these costs won’t appear. That’s a helpful litmus test.
What Are Operating Expenses?
Operating Expenses are the ongoing costs of running the business that don’t directly scale with customer delivery.
Examples:
Marketing campaigns and advertising spend
Rent, office operations, and general SaaS tools
Finance, HR, legal, and executive salaries
R&D supporting future product development
These costs are essential, but they support the broader business rather than directly contributing to product delivery.
Why Classification Matters
Cost classification directly affects reported gross margin. Misclassifying OpEx as COGS can lower margins artificially and distort profitability.
It also influences:
Benchmarking: Accurate classification helps you benchmark against peers by comparing gross margin profiles.
Narrative Clarity: Your gross margin tells part of your business story. A 70 percent gross margin company is positioned differently than one with 40 percent, even with similar net income.
Strategic Planning: Understanding true unit economics helps inform pricing, hiring, and automation decisions.
Common Missteps and Gray Areas
Some cost areas fall into gray zones. Here’s how to think about them:
Onboarding and Support: If onboarding is essential for a customer to activate and costs can be tied to revenue, it likely belongs in COGS. If it’s ongoing account management, it likely belongs in OpEx.
R&D Infrastructure: Servers used for product testing may seem like delivery tools, but unless they’re serving paying customers, they typically stay in OpEx.
Customer Success Teams: If team members focus on onboarding or technical support, consider splitting costs. Assign delivery-based roles to COGS, and retention or relationship roles to OpEx.
Example: A cybersecurity startup offering managed detection as part of its SaaS platform would likely classify analysts who monitor threats for each customer under COGS. Meanwhile, the team responsible for internal dashboards and customer health reviews would fall under OpEx.
The key is to be consistent. Use a clear framework and apply it throughout your reporting. If you change how something is categorized, document the rationale and update internal and external financials accordingly.
Final Thoughts
Cost classification does more than adjust a line item on your income statement. It shapes how your business is perceived, how you’re benchmarked against peers, and how you make decisions internally.
If you’re early-stage, it’s worth setting a strong foundation now. And if you’re growing, reviewing classifications during quarterly close or fundraising prep can offer helpful insights.
Founders often revisit this work right before board meetings or diligence. Taking time to build this structure now can save effort and build investor confidence later.
If you’re looking to better align your reporting with strategy, I’m always happy to help others think through what has worked well in similar situations, reach-out today.
