Operating expenses for SaaS companies: A complete guide

Controlling operating expenses is a strategic necessity for SaaS businesses aiming for sustainable growth. Managing these costs directly influences profitability, runway, and long-term financial health.

This guide delivers strategies and actionable insights, designed to help SaaS companies navigate and optimize their operating expenses. We'll cover everything from distinguishing between operating and capital expenses to leveraging modern tools for expense tracking.

Read on to learn:

• The essential differences between operating and capital expenditures
• Key categories of operating expenses and how they specifically relate to SaaS
• Tactics to reduce expenses without compromising growth
• Tools and frameworks for efficient expense tracking and analysis

Let’s get started by sharing a definition of operating expenses.

What are operating expenses?

Operating expenses, often shortened to OpEx, are the costs a business incurs to keep its day-to-day operations running. Essentially, these are the ongoing costs that are not directly tied to the production of goods or services. Instead, they represent the essential expenditures required to maintain the core functions of a business.

A key distinction is that operating expenses differ from capital expenditures (CapEx) and the Cost of Goods Sold (COGS). Capital expenses are one-time purchases of assets with a lifespan of more than a year, like equipment or buildings.

COGS represents the direct costs of producing goods or services. Operating expenses, on the other hand, cover the ongoing costs of running the business itself.

Common categories of operating expenses

Understanding the various categories of operating expenses is essential for effective financial management. These expenses can be broken down into several key areas:

• Selling, general, and administrative (SG&A): This category contains a wide range of costs, including salaries, rent, utilities, office supplies, and administrative fees. Primarily, these are the costs associated with running the general operations of the business.
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• Research and development (R&D): These expenses are incurred for the development of new products or the improvement of existing ones. Crucially, this is an investment in the future of the company.
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• Marketing and advertising: These expenses cover the costs of promoting the business and its products or services. Notably, they include advertising campaigns, market research, and promotional materials.
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• Payroll and employee wages: This includes all costs related to employee compensation, such as salaries, wages, and benefits. These costs are a significant portion of operating expenditures.
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• Rent and utilities: These are the costs associated with the physical space the business occupies, including rent, electricity, water, and other utilities.
• Insurance: Costs related to insuring the company, its property, and its employees.

Note: There's an operating expenses formula you can learn about in our article on the topic.

Operating expenses vs. capital expenses

Capital expenses (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. CapEx expenses are investments in the long-term future of the business, whereas operating expenses are the day-to-day costs.

Here's a table comparing operating expenses and capital expenses:

Understanding the distinction between operating expenses and capital expenses is crucial for finance teams. It directly impacts financial reporting, tax liabilities, and investment decisions.

Treating CapEx as OpEx, or vice versa, can lead to inaccurate financial statements and misinterpretations of a company's financial health. Categorizing these expenses confirms that financial reports reflect the true cost of running the business and the value of its assets.

Note: Learn more about how FinOps tools and KPIs can help manage these expenses.

Why operating expenses matter to SaaS businesses

For SaaS businesses, managing operating expenses is a strategic imperative. These costs directly affect profitability and runway, which are critical for sustainable growth. Let’s look at three key areas where OpEx matters for SaaS companies:

• Impact on profitability and runway: SaaS businesses often operate with a subscription model, where upfront costs are high, and revenue is realized over time.
  
  Keeping operating expenses under control is vital to guarantee profitability. High expenses can quickly deplete a company's runway, limiting its ability to invest in growth or weather market fluctuations.
• Role in budgeting and forecasting: Accurate budgeting and forecasting of operating expenses are essential for financial planning. It enables SaaS companies to predict future cash flows, allocate resources effectively, and make informed decisions about pricing and investment.
  
  Plus, it helps in setting realistic financial targets and monitoring performance against those targets.
• Cost-efficiency metrics and strategic operations: Tracking cost-efficiency metrics, such as the operating expense ratio, provides insights into how well a SaaS company is managing its costs. A lower ratio indicates greater operational efficiency.
  
  Also, understanding these metrics allows for strategic adjustments to operations, such as renegotiating vendor contracts or implementing cost-saving technologies. Ultimately, it supports the overall strategic operational health of the company.

Common operating expense examples by category

Understanding the specific types of operating expenses within each category can provide clearer insight into where your SaaS business's funds are allocated. It allows for better tracking and control of costs. Here’s a breakdown of common operating expenses by category:

Operating expenses in SaaS and tech companies

SaaS and tech companies have unique operating expenses that distinguish them from other industries. Let’s zoom in on those.

Recurring cloud and software costs

A major component of their OpEx is recurring cloud and software costs. Specifically, these include expenses for services like AWS, Azure, or Google Cloud, and subscriptions to various software tools vital for operations.

DevOps and engineering

DevOps and engineering costs also play a significant role. Notably, they encompass salaries for developers and engineers, as well as expenses for development tools and infrastructure.

Go-to-market (GTM) functions

Go-to-market (GTM) functions, including sales, customer success, and marketing, represent another substantial expense category. Primarily, these costs include salaries, commissions, advertising spend, and tools for customer relationship management.

Subscription tools

Subscription tools for subscription management and automated invoicing are also unique to SaaS models. Essentially, they help manage recurring payments, dunning, and customer retention.

Why SaaS OpEx looks different

The SaaS business model leads to a different OpEx profile compared to traditional brick-and-mortar businesses. The heavy reliance on tech, cloud services, and digital marketing creates a cost structure that is weighted towards these areas.

That’s why understanding and managing these specific operating expenses is critical for the financial health of SaaS and tech companies.

How to analyze OpEx for better decision-making

Analyzing operating expenses is important for making informed decisions that drive profitability and sustainable growth. It transforms raw financial data into actionable insights. Here’s what to take into account when analyzing OpEx.

OpEx trends and ratios

Start by examining trends in your operating expenses over time. Specifically, look for patterns and anomalies that may indicate areas of concern or opportunity.

Ratios, such as operating expense as a percentage of revenue, offer a clear picture of how expenses relate to sales. Moreover, they enable you to track changes and assess overall financial health.

Operating expense ratio (OER)

The operating expense ratio (OER) is a key metric that shows the percentage of revenue used to cover operating expenses. A lower OER often indicates better cost control and higher profitability. It can be calculated with the formula:

(Operating Expenses - Depreciation) / Gross Revenue.

Benchmarks by industry

Compare your operating expenses against industry benchmarks. It provides context and helps identify areas where your company may be overspending or underperforming. Furthermore, it allows for a more realistic assessment of your financial standing.

Variance analysis

Use variance analysis to compare actual expenses against budgeted amounts. Primarily, it reveals the reasons for deviations and helps pinpoint areas needing adjustment. Therefore, it allows for proactive measures to control costs and improve forecasting accuracy.

Note: Learn more about specific SaaS company benchmarks here.

Operating expenses on the income statement

Operating expenses are a key component of the income statement, offering insights into a company's operational efficiency.

They appear after gross profit and before operating income (EBIT). This placement helps distinguish between the costs of producing goods or services and the costs of running the business. Here’s a simplified income statement structure:

Remember: Understanding the differences between gross, operating, and net income is vital. Gross profit reflects the profitability of producing goods or services.

Operating income shows the profitability of core operations. Net income represents the company's total profit after all expenses, including taxes and interest.

Non-operating expenses: What to exclude

Non-operating expenses are costs unrelated to a company’s core business activities. They include interest expense, income taxes, and one-time charges, such as losses from asset sales or lawsuit settlements. Therefore, these items are excluded from operating expenses.

Separating operating and non-operating expenses is required for accurate financial analysis. It provides a clearer picture of a company's operational performance, allowing investors and analysts to assess its core profitability.

Plus, it is vital for financial modeling, as it allows for more accurate forecasts of future earnings based on operational trends. Ultimately, it helps in making informed decisions about the company's financial health and future prospects.

Note: A chart of accounts is the foundation for producing accurate financial documents like income statements. Learn more about them in our post on SaaS company charts of accounts.

Tactics to reduce operating expenses without sacrificing growth

Reducing operating expenses is a strategic move, not a cost-cutting frenzy. It’s about finding ways to be more efficient without hindering growth. Here are some tactics to consider:

• Optimize cloud costs: Analyze cloud service usage and spot underutilized resources. You can implement auto-scaling and serverless architectures to pay only for what you use. Also, negotiate volume discounts with cloud providers.
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• Automate processes: Use automation tools to reduce manual labor in areas like customer support, billing, and data entry. Automating repetitive tasks frees up staff to focus on higher-value activities.
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• Negotiate vendor contracts: Regularly review vendor contracts and negotiate better terms. Look for opportunities to consolidate vendors or switch to more cost-effective alternatives. This way, it is possible to reduce costs without compromising quality.
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• Implement remote work policies: Reduce office space and related expenses by implementing or expanding remote work policies. Likewise, it can also broaden your talent pool and improve employee satisfaction.
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• Refine marketing spend: Focus on marketing channels with the highest return on investment (ROI). Use data analytics to track campaign performance and reallocate resources. Consider digital marketing strategies like SEO and content marketing.
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• Boost customer retention: Invest in customer success and retention programs to reduce churn. Retaining existing customers is often less expensive than acquiring new ones. What’s more, it provides a stable revenue base.
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• Data-driven decisions: Use data to make informed decisions about spending. Specifically, analyze spending patterns to identify areas where costs can be reduced. Doing so allows for a more strategic approach to cost management.

Note: Want to learn more about how to optimize your subscription revenue? Check out our article on SaaS billing best practices.

Tools and frameworks to track operating expenses

Effectively tracking operating expenses is essential for financial control and strategic decision-making. Fortunately, several tools and frameworks can help SaaS businesses achieve this. Let’s look at some of those in more detail.

ERP and finance software

Enterprise resource planning (ERP) and finance software provide a centralized platform for managing financial data. Specifically, they integrate various functions, such as accounting, budgeting, and reporting, offering a holistic view of operating expenses.

Moreover, they automate data collection and analysis, reducing the risk of errors and improving accuracy.

FP&A platforms

Financial planning and analysis (FP&A) platforms offer advanced tools for forecasting and budgeting. They allow for scenario planning, variance analysis, and real-time reporting, enabling businesses to monitor and control their operating expenses effectively.

This way, they help finance teams to make decisions backed by data and adjust strategies as needed.

Custom dashboards and metrics

Custom dashboards provide a visual representation of key operating expense metrics. Essentially, they allow businesses to track performance against targets and identify trends and anomalies.

Notably, metrics such as the operating expense ratio (OER), customer acquisition cost (CAC), and customer lifetime value (LTV) can be monitored monthly to assess financial health.

Remember: Regular monitoring of operating expenses is crucial for proactive management. Specifically, tracking metrics like monthly recurring revenue (MRR), burn rate, and gross margin helps businesses identify potential issues and take corrective actions.

FAQs

Is rent an operating expense?

Yes, rent is typically considered an operating expense, as it's a regular cost necessary for running a business's daily operations. It falls under the category of expenses related to occupying and maintaining business space.

Are salaries operating expenses?

Yes, salaries are operating expenses. They represent the costs associated with employee compensation, which are essential for the day-to-day functioning of a business.

How do operating expenses affect profitability?

Operating expenses directly reduce a company's profitability, as they are subtracted from gross profit to calculate operating income. Higher operating expenses lead to lower operating income and, consequently, lower net income.

Are taxes included in operating expenses?

No, income taxes are generally not included in operating expenses. They are considered a separate line item on the income statement, appearing after operating income and non-operating expenses.

Gain control over your operating costs with Orb

We've explored how crucial it is for SaaS companies to manage and understand their operating expenses. Now, let's see how Orb, the done-for-you billing platform, can be a strategic asset in controlling and optimizing these costs.

Orb helps you to gain control over your operating expenses through:

• Precise usage-based cost alignment: Orb's ability to accurately track and bill based on customer usage means your costs directly correlate with revenue. You avoid overspending on resources that aren't generating income, a critical aspect of controlling operating expenses.
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• Real-time data for informed resource allocation: With Orb's reporting, you get immediate insights into usage and revenue trends. This way, you can make data-driven decisions about resource allocation, confirming that your spending supports high-value activities and minimizes waste.
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• Frictionless integration for financial clarity: Orb integrates smoothly with your existing accounting and financial tools, simplifying revenue tracking and financial reconciliation. This reduces manual effort and errors that can inflate operating costs.
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• Granular usage data for cost optimization: Orb provides detailed usage data, allowing you to identify areas of high and low consumption. This granular view lets you optimize spending by focusing resources on profitable features and adjusting pricing for less-used services.
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• Accurate billing to minimize revenue leakage: Orb's precise billing eliminates errors and ensures that you capture all revenue due when invoicing. It helps reduce revenue leakage, lowering your operating expense ratio.

Ready to transform your billing process from a cost center to a strategic asset? Explore how Orb can help you optimize your operating expenses and discover our flexible pricing optionsdesigned to support your business at every stage.