Rule of 40: Formula, SaaS Example and How to Calculate It

The Rule of 40 formula for SaaS (growth rate + profit margin), a worked example with ARR growth and EBITDA margin, and which inputs to choose.

Summary

Rule of 40 score = Revenue growth rate % + Profit margin %. SaaS companies scoring 40 or more are commonly considered to balance growth and profitability well. A company growing ARR 30% with an 11% EBITDA margin scores 41, just above the line.

On this page
  1. Rule of 40 formula
  2. How to calculate rule of 40 in Excel and Google Sheets
  3. Worked example
  4. How to interpret rule of 40
  5. Common mistakes
  6. Calculate rule of 40 with Better Analyst
  7. Further reading
  8. FAQ

Rule of 40 formula

Formula
Rule of 40 score = Year-over-year revenue (or ARR) growth % + Profit margin % (EBITDA margin or free-cash-flow margin)
  • Growth rate: Year-over-year growth in ARR or trailing-twelve-month revenue, in percent.
  • Profit margin: EBITDA margin or free-cash-flow margin for the trailing twelve months, in percent. Choose one and keep it consistent.

How to calculate rule of 40 in Excel and Google Sheets

Excel, using the cells in the worked example below:

Excel
=(B3/B2-1)*100+(B5/B4)*100

Worked example

A mid-market HR software company is preparing for a fundraise and wants to show where it stands on the Rule of 40 using ARR growth and EBITDA margin.

Growth and profitability inputs (table starts in cell A1)
MetricValue
ARR 12 months ago$8,200,000
ARR today$10,660,000
Trailing 12-month revenue$9,350,000
Trailing 12-month EBITDA$1,028,500
  1. ARR growth = 10,660,000 ÷ 8,200,000 − 1 = 30.0%.
  2. EBITDA margin = 1,028,500 ÷ 9,350,000 = 11.0%.
  3. Rule of 40 score = 30.0 + 11.0 = 41.0.
  4. Sensitivity: if growth slows to 25% next year, the margin needs to reach 15% to stay at 40.

Result: 41.0 Rule of 40 score (30.0% growth + 11.0% EBITDA margin)

How to interpret rule of 40

The Rule of 40 is a rough heuristic popular with SaaS investors, not a law. It lets a fast-growing, loss-making company and a slower, profitable one be compared on one scale: 60% growth with a −20% margin and 10% growth with a 30% margin both score 40. It is most meaningful for companies past early stage with steady revenue; at very small ARR, growth percentages swing too much for the score to say much. Always disclose which growth and margin measures you used, since mixing them changes the result.

Common mistakes

  • Switching between EBITDA margin and free-cash-flow margin from period to period to flatter the score.
  • Using quarter-over-quarter growth. The rule assumes annual growth; annualise or use year-over-year figures.
  • Applying it to very early-stage companies, where growth from a tiny base makes the score meaningless.
  • Mixing ARR growth with GAAP revenue margin without saying so. Both are common; disclose your choice.

Calculate rule of 40 with Better Analyst

Connect your data or upload a spreadsheet, then ask in plain English. Better Analyst writes and runs the calculation and shows the steps, so you can check the number.

  • “Calculate our Rule of 40 score for each of the last eight quarters using trailing-twelve-month figures.”
  • “Show Rule of 40 with EBITDA margin and with free-cash-flow margin side by side.”
  • “What EBITDA margin do we need next year to stay above 40 if growth slows to 22%?”

Usually calculated from: Google Sheets, Google BigQuery, Snowflake, PostgreSQL, Microsoft SQL Server.

Try Better Analyst free

Further reading

Frequently asked questions

Should the Rule of 40 use EBITDA or free cash flow?
Both are common. EBITDA margin is easier to calculate from the P&L; free-cash-flow margin better reflects cash generation. Pick one and disclose it.
Can a company with negative margins pass the Rule of 40?
Yes, if growth is high enough. 55% growth with a −10% margin scores 45.
What growth rate does the Rule of 40 use?
Year-over-year growth in revenue or ARR, usually trailing twelve months versus the prior twelve months.