You're growing fast and your investors are happy. But are you burning too much cash to get there? Or maybe you're profitable but growth has slowed. The rule of 40 quickly shows balance between growth and profitability, all in one number.
Finance teams use this benchmark to guide business decisions, prep for fundraising, and show results to investors. Here, you'll see what the rule of 40 is, how to use it, why it matters, and how to track it in Runway.
Understanding the rule of 40
Calculate the Rule of 40 by adding your revenue growth rate to your profit margin. If the total hits 40% or higher, you’re on target. For example, A company with 20% revenue growth and a 20% profit margin lands exactly on 40%.
SaaS teams rely on this metric to evaluate businesses trading near-term profits for rapid expansion. It helps you balance fast growth with necessary profitability. When scaling feels chaotic, this rule confirms you’re still heading in the right direction.
Consider the Rule of 40 a north star for finance teams. It connects your P&L data directly to strategic business priorities and helps you answer big resource questions:
- Should we boost investment in sales and marketing?
- Can we accelerate our hiring plan?
- Are we positioned effectively to raise our next round?
Investors watch this benchmark closely. Crossing 40% signals strong business health to investors, particularly in the SaaS and subscription spaces. It’s a clear indicator that your growth is sustainable.
Formula variants for growth and profitability
You compute the rule of 40 by adding revenue growth rate to profit margin. But you can measure profit margin in several ways. The best choice depends on your business model and what you want to show.
Standard formula: revenue growth + profit margin
The classic formula combines year-over-year revenue growth and net profit margin:
Rule of 40 = YoY revenue growth % + net profit margin %
For example, if you grew revenue 35% last year and posted a 10% net profit margin, your score is 45%. This method fits mature businesses with stable margins best.
EBITDA margin approach
Some finance teams use EBITDA margin instead. A swap to EBITDA margin highlights core operations. This means you focus strictly on the profitability of your day-to-day business activities. It strips away the noise from financing choices, tax environments, or accounting decisions so you see exactly how your product performs.
Rule of 40 = YoY revenue growth % + EBITDA margin %
This works well when you compare companies with different debt levels. It excludes interest, taxes, depreciation, and amortization from the equation.
Free cash flow margin alternative
Free cash flow margin puts the focus on cash. Add annual growth to free cash flow margin to get a cash-first view:
Rule of 40 = YoY revenue growth % + free cash flow margin %
This matters because cash, not revenue, keeps you running. Free cash flow margin shows real cash output. Get insights on this in our deep-dive on revenue vs. cash flow.
Which formula should you use?
Pick the formula that matches your business and goals. Use EBITDA margin to compare capital structures. Pick free cash flow margin when cash matters most. Use net profit margin when you want to show bottom-line strength.
Stay consistent. Stick with one formula so you can track changes and trends.
Key components and considerations
Getting the Rule of 40 right requires measuring the right numbers in the right way.
Calculating revenue growth rate
Year-over-year growth usually works best since it smooths out seasonal swings. Month-over-month data can be enticing, but the variance is often too high for this metric. For SaaS, you simply need to choose between ARR growth or total revenue growth.
- ARR works well for subscription businesses because it ignores one-offs to keep data clean.
- Total revenue growth fits better if your model relies on usage-based or transaction revenue.
ARR doesn't fit every model, especially with the rise of AI and usage-driven billing. ARR has limits for some models. Pick the metric that actually matches your revenue stream.
Selecting the appropriate profitability metric
Pick a profitability style that reflects your actual operations. EBITDA margin makes sense when you have significant depreciation or amortization. Operating margin gives you a view of all operating expenses. If cash drives your strategy, stick with free cash flow margin.
Be transparent about stock-based compensation. While practices vary, investors usually want to see it included. Keep your reporting consistent so stakeholders know exactly what they're looking at.
Determining the right time period
Use trailing twelve months for both growth and profitability to keep your numbers in sync. Mixing quarterly and yearly metrics creates unreliable results.
Forward-looking projections illuminate the road ahead. Model how hiring plans or spending cuts change your score over the next year to stay proactive.
Handling seasonality and one-time items
Full-year periods account for seasonality better than short bursts. A seasonal business might look strong in peak months but fail to sustain that pace all year. Exclude one-time items like restructuring charges or major gains to focus entirely on ongoing performance.
Challenges for varying growth stages
If you haven't hit significant revenue yet or you're in hypergrowth mode, the Rule of 40 might not apply perfectly just yet. You might show rapid growth alongside significant losses, which scores well on paper but lacks stability.
Focus on growth and unit economics in the early days. The Rule of 40 becomes more meaningful once you have established revenue and a clear path to profit. Check out our investor criteria guide for metrics that help teams navigate early growth phases.
Why it matters and how to use it
The Rule of 40 forces you to weigh growth and profitability together. You get a clean, holistic view of your business health without the noise.
Investor expectations and valuation
Investors love this metric for a quick viability check. It balances growth against profit to weigh near-term losses against future value. Companies that score above 40% often see premium valuations. Palantir hits the mark with strong growth and margins as a prime example.
Use this rule to anchor your financial story during fundraising. If you score high, show off your strengths. If you sit lower, present a clear plan to improve. Check our fundraising prep guide for a step-by-step approach.
Growth vs. profitability tradeoffs
The Rule of 40 clarifies where your tradeoffs land. You can grow 50% with a -10% margin to hit 40%. You can also reach the same score by growing slower with better margins. The metric helps you compare different paths for your model.
Some teams lean into speed. Research Solutions pushes growth with an eye on their Rule of 40 goal. Others focus on the bottom line. The rule makes your choice deliberate.
Operational efficiency and burn rate management
Profitability connects directly to burn rate. A 40% growth rate combined with a -20% margin puts you at a total score of 20%. That signals a need to push growth harder or trim costs.
Real stability requires tracking cash alongside these percentages. The Rule of 40 unifies your growth story with cash realities. Our cash flow metrics guide offers extra detail on what to monitor.
Strategic decision-making
Use the Rule of 40 to evaluate big moves. Model changes to growth and margins before you expand into new markets. Check how a new product launch impacts your score.
This metric guides resource allocation too. If you sit at 45% and want to make a big sales hire, use scenario planning to compare growth acceleration against margin shifts. Runway’s scenario tools let you compare these outcomes side by side so you can plan with confidence.
Common benchmarks and pitfalls
Benchmarks by stage and performance
The 40% threshold acts as a guideline rather than a strict rule. Your current stage impacts what counts as good performance.
- Early-stage companies often score below 40% while focusing on growth. Keep an eye on unit economics and chart a path to profit.
- Growth-focused businesses should aim for 40% or better to show you can scale with discipline.
- Best-in-class teams go above 60%. Palantir, for example, hit a score of 64 with strong growth and healthy profit margins.
Compare your results against market peers at a similar scale. Look beyond public giants and find firms relevant to your specific stage and sector.
Common calculation mistakes
Watch for these common errors to keep your data reliable.
- Pick one metric for growth. Stick to either ARR growth or total revenue growth.
- Match your timeframes. Use trailing twelve months for both margins and growth rather than blending quarterly and annual numbers.
- Disclose stock-based compensation handling. Be clear if you exclude it.
- Normalize your data. Remove one-offs for consistent results.
Interpretation pitfalls
Trailing numbers show where you’ve been while projections help you plan where you’re going. Use both when making strategic calls.
Compare companies with full context since a lower score often fits fine at certain stages. Focus on trends and improvement rather than one-time snapshots. This metric serves as a guide rather than a hard target. Improvement matters more than perfection, so make deliberate moves to get better over time.
Account for margin differences by industry. Adjust your expectations knowing SaaS margins often beat hardware.
Aim for healthy growth and margins. Keep track of your other core metrics too. Review our financial ratios guide for a broader perspective.
How to calculate the rule of 40 in Runway
Tracking the rule of 40 is simple with Runway. Here’s how you can do it step-by-step.
Step 1: set up your revenue model
Start by forecasting your revenue in Runway. Our SaaS revenue forecasting guide walks you through modeling by customer tier, tracking churn, upgrades, and connecting every assumption.
You should include both past results and projections. You need twelve months of data to establish solid year-over-year growth.
Step 2: calculate revenue growth rate
Create a driver or formula to compute your YoY revenue growth rate. You can use Runway to reference previous periods and calculate changes automatically.
Decide which metric fits your business best. You might choose ARR or total revenue. You can even build both to compare efficiently. It’s easy to split revenue streams using Runway’s dimensional modeling.
Step 3: select and model your profitability metric
Choose your margin from options like EBITDA, operating income, or free cash flow. Build your P&L and cash flow models based on that choice.
If you calculate free cash flow margin, you need to connect operating cash flow and capex. Our cash flow guide helps with this. Add stock-based compensation as a separate line. You can toggle it on or off to measure the impact instantly.
Step 4: create a rule of 40 formula
Add revenue growth and profit margin with a custom metric. Runway’s calculated fields update instantly when your underlying data changes.
Show your score as a percentage. If you’re above 40%, you’re beating the benchmark. If you’re below, it’s time to optimize.
Step 5: build scenarios to model tradeoffs
Use Runway’s scenarios feature to run different strategies and see the impact. You can model:
- Base case
- Aggressive growth
- Profitability focus
Adjust growth plans, hiring, and costs in each version. See how your score moves to help you choose the best route. Compare results side by side to see which approach supports the best growth and profit tradeoff.
Step 6: track trends over time
Look beyond this quarter’s score and review your metric quarter by quarter. Build a dashboard in Runway for historical and forecast views.
This helps you spot trends early. You can see patterns that show if you are improving or holding steady.
Step 7: build a page to tell the story
Use Runway’s Pages to create a dashboard showing your rule of 40 score with underlying drivers. You can display:
- Revenue growth
- Your chosen profitability metric
- Key components driving each
This visual makes it easy to update investors, the board, or cross-team partners. Share the metric and explain the context behind your tradeoffs and optimizations.
Step 8: connect to your broader financial model
Don’t isolate the rule of 40. Connect it to cash, hiring, and fundraising. When you change headcount in Runway, the rule of 40 score updates instantly.
This speed is crucial for small, scrappy finance teams and model owners who want control without vendor bottlenecks. You’re building a connected model for confident, fast decision-making.
Frequently asked questions about the Rule of 40
What is a good Rule of 40 score for a SaaS company?
Aim for a score of 40% or higher. This benchmark signals that your SaaS business is balancing growth and profitability effectively. Investors view a score above 40% as an indicator of a healthy, sustainable model. Scores over 50% or 60% are considered best-in-class.
Can I have negative profit and still pass the Rule of 40?
Yes. You can pass the Rule of 40 even with negative profit margins if your revenue growth is high enough. For example, if your year-over-year revenue growth is 60% and your profit margin is -20%, your total score is 40%. The metric rewards rapid expansion as long as the growth justifies the burn rate.
Should I use EBITDA or free cash flow to calculate the Rule of 40?
It depends on your goals. Standard EBITDA margin highlights operational efficiency by stripping away financing and accounting effects. However, using free cash flow margin gives you a clearer picture of liquidity and actual cash generation. Many investors prefer the free cash flow method to ensure the business isn't running out of money despite "paper" profits.
How often should I calculate the Rule of 40?
Calculate this metric on a monthly or quarterly basis. While you should use trailing twelve-month data to smooth out seasonality, checking the score regularly helps you spot trends. Frequent tracking allows finance teams to adjust hiring plans or marketing spend quickly if the score starts to dip.
Paving the way to sustainable growth
The rule of 40 offers a simple framework for the classic finance challenge: balancing growth with profit. It’s not a perfect number, but it’s a useful one. It keeps your team focused on making smart, informed tradeoffs.
This metric empowers finance teams to drive informed, insightful conversations. Use it to elevate your resource allocation discussions—far beyond just chasing fast growth or simple cost cuts. You have the tools to make smarter calls together.
Track the rule of 40 consistently. Know what drives it. Use it as a compass, not the finish line. Your score will shift as your company evolves, and that’s okay. The goal is steady improvement through intentional decisions.
Runway makes tracking, modeling, and sharing your score simple. You don’t need to juggle spreadsheets. You get a live, connected model. Make decisions with confidence—and show your stakeholders where you’re heading.
Ready to see how you can monitor growth, profitability, and cash runway in one place? Book a demo and get started.