Growth & SaaS
Rule of 40
The Rule of 40 says a healthy software company’s revenue growth rate plus its profit margin should add up to at least 40%.
Rule of 40 score = Revenue growth rate (%) + Profit margin (%), usually EBITDA margin, sometimes free cash flow margin
Worked example
| Company A | revenue growth 30%, EBITDA margin 15% |
| Company B | revenue growth 55%, EBITDA margin −10% |
A: 30% + 15% = 45%. B: 55% − 10% = 45%. Both clear 40%.
Why it matters
The rule gives one way to judge the trade-off between growing fast and making money. Investors and buyers use it to compare companies at different stages on the same scale.
Common mistakes
Where it misleads
Mixing margins between periods or companies, such as EBITDA margin for one and free cash flow margin for another.
Applying it to very early companies, where growth rates on a small base make the score meaningless.
Using a single strong quarter’s growth rate annualized instead of growth over the past year.
Related terms
Keep reading
- EBITDAEBITDA is earnings before interest, taxes, depreciation and amortization: a measure of operating profit before financing, tax and non-cash charges.
- Annual recurring revenue (ARR)Annual recurring revenue is the yearly value of a company’s recurring subscription revenue at a point in time, usually MRR multiplied by twelve.
- Burn multipleThe burn multiple measures how much cash a company burns to add each dollar of new annual recurring revenue.
Stop calculating it by hand.
Dear CFO keeps your statements, forecasts and metrics current from the systems you already run.