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DownloadAnswers to Frequently Asked Questions
The rule of 40 calculation is important to measure the growth of SaaS companies. According to the Rule of 40, a software company’s combined revenue growth rate and profit margin must be at least 40%. While SaaS companies below 40% may experience cash flow or liquidity problems, those above 40% are making money at a rate that is sustainable.
The rule of 40 calculation is very simple. Simply add your growth in % along with your profit margin, also in percentage, to arrive at this metric. For instance, if your profit margin is 20% and your revenue growth is 17%, your Rule of 40 number is 37%, which is less than the 40% target.
The operating profit as a proportion of revenue is calculated using the EBITDA margin formula. Earnings before interest, taxes, depreciation, and amortisation are referred to by the term EBITDA. The EBITDA margin makes it possible to compare a company’s actual performance to that of others in its industry.
Typically, if a company achieves a combined score of 40 or more, it is considered healthy and a desirable target for purchase. The Rule of 40 scores automatically makes a trade-off between revenue growth and EBITDA.
The EBITDA margin formula is EBITDA Margin = EBITDA / Revenue. Sales revenue is used to determine earnings, subtracting from operating costs like selling, general, and administrative (SG&A) and cost of goods sold (COGS), but not depreciation and amortisation.
The Rule of 40 states that a SaaS company is viable and moving in the right direction toward maturity if its growth rate and profit margin both exceed 40%. For larger organisations, breaking the Rule of 40 in a single year is not rare.
