Rule of 40
What is Rule of 40?
The Rule of 40 adds annual revenue growth percentage to a chosen profit margin. A combined score of 40% is a common reference point, whose usefulness depends on company stage and measurement conventions.
The Rule of 40 adds a revenue growth percentage to a profit margin percentage. It is a compact way to discuss the balance between growth and profitability, but its meaning changes with the margin definition. This site’s example uses free cash flow margin; always label a different choice such as operating or EBITDA margin.
Also known as: Rule of Forty, R40
Formula
Rule of 40 Score = Revenue Growth Rate + Profit Margin | Variable | Meaning |
|---|---|
Revenue Growth Rate | Year-over-year recurring revenue growth rate, in percent. |
Profit Margin | Profitability margin, typically free cash flow margin or EBITDA margin, in percent. |
How to use it
- Calculate year-over-year revenue growth using comparable periods and a consistent revenue definition.
- Calculate the chosen margin for the current period. For FCF margin, divide period free cash flow by recognized revenue for that same period.
- Add the percentages as percentage points. Show both components next to the sum, and keep the margin basis unchanged when comparing periods.
Worked example
Hypothetical worked scenario
A fictional company grows annual revenue from $4 million to $5 million and generates $750,000 free cash flow in the latest year.
Growth = ($5 million − $4 million) ÷ $4 million = 25%. FCF margin = $750,000 ÷ $5 million = 15%. Rule of 40 score = 25 + 15 = 40%.
Another company with 60% growth and −20% margin also scores 40%. The matching score conceals very different cash needs and operating conditions.
Calculate with your numbers
Rule of 40 Score = Revenue Growth Rate + Profit Margin | Variable | Meaning |
|---|---|
Revenue Growth Rate | Year-over-year recurring revenue growth rate, in percent. |
Profit Margin | Profitability margin, typically free cash flow margin or EBITDA margin, in percent. |
Worked example
- Revenue Growth Rate
- 25%
- Profit Margin (FCF or EBITDA)
- 15%
- → Rule of 40 Score
- 40%
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Open the Rule of 40 calculator for a focused view of the inputs.
What the result tells you
Treat 40 as the threshold named by this heuristic, not an independently sufficient test of business quality. Compare retention, cash consumption, and scale before drawing conclusions. A short operating history or tiny revenue base can make growth percentages especially unstable.
Assumptions and common mistakes
- Do not mix an EBITDA-based peer score with your FCF-based score without explaining the difference.
- Use percentages consistently: entering 25 and 15 produces 40%, not 0.4%.
- A score can improve through spending cuts that damage future growth; examine the components and customer outcomes.
Compare related measures
Frequently asked questions
Can I enter a negative margin?
Yes. A loss or negative free cash flow lowers the score. A 50% growth rate and −15% margin produce 35%.
Is 40% enough to value a company?
No. A valuation depends on many inputs, and two companies with the same score can have different revenue quality, risk, and cash requirements.
Sources and methodology
The references below explain the underlying methods. Our worked scenarios use hypothetical figures; they are not company results or current market benchmarks.
- Bessemer: The Rule of X
Discussion of growth, free cash flow margin, and the limitations of the Rule of 40.
Found an error or a definition that differs from your reporting? Send a correction with the page URL and the method you use.