Transparent method
The formula
Worked example
Example inputs
How to interpret the result
The Rule of 40 combines growth rate and profit margin into one number specifically so that a fast-growing, unprofitable company and a slower-growing, highly profitable one can both score well, which is deliberate. The rule doesn't say either path is better, only that the combination should clear a general threshold, not that 40 is a universal pass-fail line for every company at every stage.
Before you rely on it
What to check
Use a consistent, clearly defined profit measure when calculating the score, and treat 40 as a general benchmark rather than a fixed pass-fail line for every company regardless of stage.
The common error
Where people go wrong with saas rule of 40 calculator
Treating a Rule of 40 score below 40 as an automatic red flag regardless of company stage or strategy. An early-stage company deliberately prioritizing growth over near-term profit, or the reverse, can have good reasons for scoring below the threshold at a specific point in its life.
Sensitivity evidence
How annual recurring-revenue growth changes the rule of 40 score
| Annual recurring-revenue growth | Rule of 40 score | Distance from 40 | Entered growth plus margin |
|---|---|---|---|
| 26.0% | 38.0% | -2.0% | 38 |
| 28.0% | 40.0% | 0.000% | 40 |
| 30.0%worked example | 42.0% | 2.0% | 42 |
| 32.0% | 44.0% | 4.0% | 44 |
| 34.0% | 46.0% | 6.0% | 46 |
Every input, tested
Which input moves the rule of 40 score most
| Input | Tested from | To | Rule of 40 score at each end | Swing |
|---|---|---|---|---|
| Annual recurring-revenue growth | 28.0% | 32.0% | 40.0% to 44.0% | 4.0% (9.5%) |
| EBITDA or free-cash-flow margin | 10.0% | 14.0% | 40.0% to 44.0% | 4.0% (9.5%) |
Two variables at once
Rule of 40 score by annual recurring-revenue growth and EBITDA or free-cash-flow margin
| Annual recurring-revenue growth \ EBITDA or free-cash-flow margin | 8.0% | 12.0% | 16.0% |
|---|---|---|---|
| 26.0% | 34.0% | 38.0% | 42.0% |
| 28.0% | 36.0% | 40.0% | 44.0% |
| 30.0% | 38.0% | 42.0% | 46.0% |
| 32.0% | 40.0% | 44.0% | 48.0% |
| 34.0% | 42.0% | 46.0% | 50.0% |
Step by step
The worked example, input by input
| Input | Value used |
|---|---|
| Annual recurring-revenue growth | 30.0% |
| EBITDA or free-cash-flow margin | 12.0% |
| Rule of 40 score | 42.0% |
| Distance from 40 | 2.0% |
| Entered growth plus margin | 42 |
Where the inputs come from
Annual recurring-revenue growth is the year-over-year growth rate of ARR or revenue, and the margin is EBITDA margin or free cash flow margin as a percent of revenue. Use consistent definitions across periods and peers, and say whether you use EBITDA or free cash flow. Both should cover the same twelve months. Negative margins are entered as negative numbers.
When the result stops applying
The rule is a heuristic and not a law, and it fits scaled software companies better than early startups. Margin choices, such as adjusted EBITDA excluding stock compensation, change the score. Growth and margin can be traded off in different ways that have very different risks. A single year's score can mislead.
What to compare it with
See the components on the MRR growth and EBITDA margin calculators, and the efficiency of spending on the magic number and CAC payback pages. The net revenue retention page shows the quality of growth. Track the score quarterly.
People also ask
Frequently asked questions
What is the rule of 40?
A guideline that a software company's revenue growth rate plus its profit margin should be at least 40%, balancing growth against profitability.
Which margin should I use?
EBITDA margin or free cash flow margin, applied consistently. Free cash flow is stricter since it includes capital and working-capital needs.
Does every company need to pass?
Not necessarily. Early-stage companies often score lower because they invest heavily in growth, but the rule is a common benchmark for maturity.