May 2023
Adam Hoeksema
The IRS publishes tax return data each year on the roughly 28,000,000 sole proprietorships in the U.S. We analyzed the 295,814 tax returns that were filed in the software development industry to pull out some key statistics and insights to help our customers ensure that they are creating realistic financial projections for their software development business.
We hope that this data will be helpful for you as a “reality check” for your financial projections and software development business planning process. We hope you create a forecast for your unique situation and plan, and then use this data to make sure your projections seem reasonable based on industry averages.
Here is what we will cover in this article:
Learn How to Use this Financial Data
If you are creating projections for your startup business, or you just want to see how your existing business stacks up to industry averages, you can take your income statement and compare key ratios and percentages for your business compared to this industry average data.
How many software development businesses in the US are sole proprietorships
There are roughly 295,000 software development businesses in the US organized as sole proprietorships. We specifically analyzed 295,814 software development companies based on the 2019 IRS tax return data.
Average annual revenue for a software development business
The average annual revenue for all sole proprietorship software development businesses in the U.S. was just $43,767.
This seemed a bit low. However, I think we need to remember that this tax return data includes all sole proprietors that categorize themselves in the “software development” industry. This means it could include businesses that are just part time side hustles with a little bit of consulting or product revenue.
This underscores the importance of actually creating your own projections. We have a number of templates that could be utilized for different types of software businesses. We have a professional services model for software developers that are simply creating software for other companies. We also have templates for software businesses like enterprise SaaS, hardware as a service, or B2C SaaS.
Average annual expenses for a software development business
The average annual expenses for all sole proprietorship software development businesses in the U.S. was $25,134.
The average annual expenses for software development will be made up of traditional expenses such as rent, but also measuring cost per customer acquisition (marketing and sales), but these all could vary depending on the business, so again let’s not focus too much on the specific dollar amounts here. What we can gain from this tax return data is an understanding of expenses and profits as a percentage of revenue rather than a specific dollar amount.
Average net profit margin for a software development business
The average net profit margin for a software development business was 43%.
This was one of the highest profit margin industries that we looked at, right up there next to lawyers!
How much can I make by owning a software development business?
In order to calculate the earnings potential of a software development you can take the following assumptions:
- # of customers
- Average billable hours per customer per month
- Average billable rate
These assumptions will allow you to come up with a revenue forecast for your software development. From there you can apply the 43% profit margin.
Top 10 expenses for a software development business
Based on the tax returns of roughly 295,814 sole proprietors operating in the software development industry, the following were the 10 largest business expenses as a percentage of revenue.
Average material cost of goods sold for a software development business
The average software development business spent 8% of annual revenue on material cost of goods sold.
Since this is a software business, we assume that the “material cost” might be things like website hosting, 3rd party software tools like Github, etc.
Average contact labor for a software development business
The average sole proprietor software development business spent roughly 7% of annual revenue on contract labor.
This seemed odd at first, but given the specialty and start up nature of software development, additional specialized workers may be needed. It is common to see these workers be contractors rather than full time employees.
Average other business expenses for a software development business
The average sole proprietor software development business spent roughly 7% of annual revenue on salaries and wages.
This can be a bit of a catch all and due to the unique nature of SaaS and software development, this category could vary.
Average salaries and wages for a software development business
The average software development business spent roughly 5% of annual revenue on salaries and wages.
Given that software is often developed and then delivered separately, there is a need to service customers after the fact and provide support. This is vital to ensure a long customer life and low churn rate.
Important Details about the Data
I want to point out a few key items about the data:
- You can download this data for free from the IRS website.
- The data includes 295,814 Software Development sole proprietorships in the U.S. in 2019.
- This data will include businesses that operate full time, and businesses that only operate on a part time basis.
- Because of this, you should take the raw numbers for revenue, expenses and profit with a grain of salt, but the percentages can still be quite valuable when trying to forecast expenses for your business.
- This data includes businesses from all across the country, keep in mind that revenue and expenses can vary greatly based on your specific geographic location.
- We used 2019 data because we felt it was most likely to be representative of a “normal” environment for the industry. COVID-19 caused disruption to almost every business in 2020 and 2021, so we wanted to utilize “normalized” data.
If you have any questions about the data or how to utilize the data in your financial forecasting process please don’t hesitate to reach out to us!
