Definition
Rule of 40 is a common SaaS heuristic: revenue growth rate (%) plus profit margin (%) should be around 40% or higher. It is a coarse way to balance growth and profitability.
Formula
Rule of 40 score = growth rate (%) + profit margin (%)
Which margin should you use-
- Operating margin: good for operating performance comparisons.
- EBITDA margin: common in SaaS reporting but can differ from cash.
- Free cash flow margin: ties to cash efficiency but can be volatile.
- Pick one and keep it consistent over time.
When Rule of 40 is useful
- As a high-level balance check between growth and profitability.
- For peer comparisons when accounting rules are similar.
- To spot when growth is too costly or profits are too low.
Stage context
Early-stage companies often prioritize growth and may run below 40 while building product-market fit. Later-stage companies are expected to improve margins as growth stabilizes. Use trend and stage context, not a single snapshot.
How to improve your score
- Improve gross margin by reducing variable costs.
- Reduce churn and contraction to lift revenue growth quality.
- Shift spend from low ROI acquisition to higher LTV segments.
- Tighten operating expenses without cutting core product value.
Rule of 40 checklist
- Use the same growth definition each period (ARR, MRR, or revenue).
- Use the same margin definition each period (operating, EBITDA, or FCF).
- Explain what is driving the score, not just the number itself.
How to improve the score without gaming it
- Improve retention to lift growth without increasing spend.
- Raise prices where value is proven, not across the board.
- Reduce low-ROI acquisition channels before cutting core product spend.
Reporting tips
- Use the same reporting period for growth and margin inputs.
- Explain the drivers behind growth and margin changes.
- Show trailing averages to reduce monthly noise.
Common mistakes
- Mixing different margin types across periods.
- Comparing across companies with very different accounting and GTM models.
- Using Rule of 40 as a single KPI instead of a context metric.