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

- URL: https://betteranalyst.com/metrics/rule-of-40
- Published: 2026-11-01
- Updated: 2026-11-01
- Author: David Bressler, Founder (https://betteranalyst.com/authors/david-bressler)

> **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.

Category: [SaaS](https://betteranalyst.com/metrics#saas)

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.

## Rule of 40 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:

```
=(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)*

| Metric | Value |
| --- | --- |
| 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](https://betteranalyst.com/data-connectors/google-sheets), [Google BigQuery](https://betteranalyst.com/data-connectors/bigquery), [Snowflake](https://betteranalyst.com/data-connectors/snowflake), [PostgreSQL](https://betteranalyst.com/data-connectors/postgresql), [Microsoft SQL Server](https://betteranalyst.com/data-connectors/mssql).

[Try Better Analyst free](https://betteranalyst.com/signup)

## Further reading

- [How to calculate EBITDA](https://betteranalyst.com/metrics/ebitda)
- [CAGR formula](https://betteranalyst.com/metrics/cagr)
- [Year-over-year growth formula](https://betteranalyst.com/metrics/year-over-year-growth)
- [Better Analyst for finance teams](https://betteranalyst.com/solutions/finance)

## 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.

## Related metrics

- [How to Calculate ARR: Annual Recurring Revenue Formula](https://betteranalyst.com/metrics/annual-recurring-revenue)
- [How to Calculate EBITDA: Formula, Example and EBITDA Margin](https://betteranalyst.com/metrics/ebitda)
- [Net Revenue Retention (NRR): Formula and Worked Example](https://betteranalyst.com/metrics/net-revenue-retention)