Add growth rate to profit margin and test the result against the 40 per cent software benchmark.
The rule treats growth and profitability as interchangeable: a business growing 40% while break-even scores the same as one growing 10% at a 30% margin. It is a screen for whether losses are buying enough growth to justify them. It is the most widely used single test of software company quality, and falling below 40 is what triggers pressure to trade growth for margin.
Rule of 40
Rule of 40 score = revenue growth % + profit margin %
Rule of 40 score = revenue growth % + profit margin % The rule treats growth and profitability as interchangeable: a business growing 40% while break-even scores the same as one growing 10% at a 30% margin. It is a screen for whether losses are buying enough growth to justify them.
It is the most widely used single test of software company quality, and falling below 40 is what triggers pressure to trade growth for margin.
This calculator takes 2 inputs: Year-on-year revenue growth, EBITDA or free cash flow margin. The pre-filled defaults are a realistic starting point — replace them with figures from your own environment for a result you can act on.