A SaaS Guide to Tracking and Managing R&D Expenses

In this article, we’ll take a look at these costs and how they fit into your overall vision — what they are, how to track them, and how to make sure you’re getting the highest return on investment possible.

What Are R&D Expenses?

R&D expenses are any costs connected to the research and development of your product, directly or indirectly.

For SaaS companies, major R&D costs include:

• Software development costs (this could be your initial product and subsequent features or a new product)
• Cloud infrastructure costs
• Intellectual property (IP) and patent costs
• Labor costs of employees involved in R&D (think engineers)

Under GAAP, R&D expenses are recorded as operating expenses on your income statement. But since 2022, R&D expenses must also be capitalized and amortized for tax purposes. This means in tax accounting, you’d record them as an asset on your balance sheet. We’ll get a bit more into the tax implications further on.

Why R&D Expenses Are Crucial for SaaS Companies

At a SaaS company, your focus is all on the product — landing on your core idea, finding your product market fit, and rolling out new features in response to customer requests or market competition.

But to make this happen, you need talented engineers and software architects, and a cloud infrastructure for them to work in— in other words, R&D costs.

Early on, you can expect these research costs to be one of your SaaS company’s largest expenses. Analysis from EY puts average R&D expenditure for high growth SaaS companies as high as 30% of revenue.

As a company gets larger and the pace of growth begins to slow, this figure plateaus from a percentage standpoint, but remains a major expenditure item all the way up to and beyond IPO.

Case in point: about 1/4th of revenue is spent on R&D among SaaS companies leading up to IPO, says Blossom Street Ventures, but also in earlier stages like series C and B.

While benchmarks are useful for comparing R&D spend to successful startups at similar stages, what really matters is how R&D expenses are working for you—are they bringing you closer to milestones without shortening your cash runway to dangerous levels? Is revenue growing fast enough to keep up? How do your R&D costs compare to your other major expenses?

To answer questions like these, you need a granular view of your cost structure, and you need to measure R&D return on investment against your growth plans.

How to Track and Monitor R&D Expenses

As a significant portion of spend, it makes sense to track and monitor how your R&D expenses change over time, and how — or if — they’re driving increases in revenue.

Get Real-Time Financial Analysis With Mosaic

Normally, tracking R&D expenses means poring over spreadsheets and financial statements.

By connecting directly with your ERP, Mosaic presents a much simpler, streamlined alternative:  you get an instant, real-time view of research and development expenses and their composition, beautifully illustrated in your expense dashboard.

You can then easily evaluate not only how your spend stacks against industry benchmarks, but also how R&D costs are shifting against your budget. From there, you can communicate these discrepancies to R&D leaders before leveraging budget variance analysis to uncover the causes and drive strategic insights.

While significant, R&D is just one part of your spend. You need to consider it in the context of other expenses like G&A costs, headcount, and marketing spend.

The goal of in-depth budget analysis is to balance out top-and bottom-line growth — are your expenses driving revenue in a way that will help you achieve profitability?

For R&D, the best way to answer this question is with the R&D payback ratio. By comparing R&D costs to total revenue, the R&D payback ratio shows the return on investment for every dollar spent on R&D activities over a specific period.

R&D payback can be one key to finding your ideal product market fit and testing strategies over time. For instance, say you notice R&D spending has ballooned from 40% to 50% over the past quarter—“ok”, you recognize, “this is because we’ve been developing new features in response to competitors.”

But are those new features actually driving a return on investment? By showing if and how revenue has increased since they were introduced, R&D payback helps you answer.

R&D payback is a useful metric, but has its limitations. For example, your ratio could be low, not because your product is poor, but because you haven’t effectively communicated its value to your ICP.

On the other hand, if you have more than one product, R&D payback doesn’t tell you which product is driving an increase in revenue. Mosaic’s Metric Builder can be a great help here, allowing you to analyze R&D payback specifically by product line.

Forecast R&D Spend

The best financial models paint a moving picture of your business, one that’s continuously updated based on information sourced in real-time from ERP, CRM, and HRIS.

This current picture can then be projected into the future. Balancing top and bottom-line growth over time means forecasting your most crucial expenses, including R&D spend.

Your starting point is to forecast revenue. Then, calculate R&D costs as a percentage of revenue for past periods. To get your baseline, you work back from revenue forecasts to approximate your future R&D spend.

But there’s more to it than that. What does your product roadmap look like? Are you planning to develop new features? What is an acceptable increase in R&D spend? Build these answers into your forecasts, and use some of the benchmarks mentioned above as a guide to see where you should be in line with specific funding rounds.

If you’ve already found your PMF, on the other hand, R&D costs should decrease — now you can think about moving funds to steadily increasing the number of sales reps over time and stepping up advertising campaigns.

While forecasts can be pretty darn accurate, it’s important to temper them with scenario analysis. What if you overrun your allotted R&D budget? Or what if your R&D payback is less than expected and you need to pivot? Use scenario plans to “price in” these possibilities, giving yourself plenty of room to change course if needed.

Boost ROI With the R&D Tax Credit

We can’t talk about R&D expenses without mentioning the R&D tax credit, an excellent way of getting the most out of R&D spend. Unlike an R&D tax deduction, the R&D tax credit can potentially deposit cash into your accounts for qualifying research activities.

This credit can offset federal and state income tax liabilities, as well as FICA payroll taxes for qualified small businesses. What’s a qualified small business? One that has less than $5 million in gross receipts in the eligible year.

The R&D tax credit also allows you to go back in time up to three years to claim tax credits for past activity.

Fortunately, software development generally qualifies for the tax credit, passing the IRS’s four-part test. Still, you’ll want to work with a CPA to check off the necessary boxes.

What Expenses Qualify for the R&D Tax Credit?

Here are some expenses that qualify for an R&D tax credit:

• Cloud computing costs
• Wages for employees directly involved in research
• Payments made to contractors performing testing or research
• Supplies necessary for developing the product, like software licenses

All of these expenses must be made in the US. To learn more about the R&D tax credit, visit the IRS website.

Mosaic: Your Partner in R&D Financial Management

For SaaS companies, R&D expenses are the medium that brings your vision to life.

Mosaic can help you track research and development costs over time, gaining insights into why they’re shifting as well as how they’re driving return. You can then share this information with decision-makers outside of finance in a way that’s easy to understand, connecting the dots of spend and directing company strategy.

At the same time, you need a clear picture of how recent tax changes are affecting your cash flow. Build those payments into your financial model, and you can weather the storm by determining how to balance revenue and spending without endangering your cash runway.

Request a demo today to see how Mosaic can help you optimize your R&D spend.