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As someone who’s managing a SaaS company, you probably know how difficult it is to balance profit and revenue growth.
You need to strike a balance between rapid growth and continued profitability.
That’s where the Rule of 40 can help. It helps you assess whether your growth and profitability are balanced and if your business is scaling healthily.
If you want to learn how to use the Rule of 40 to evaluate your performance, this post will help. So, keep reading.
What is the Rule of 40 for SaaS Companies?
Think of it as a quick health check for your SaaS business.
Simply add your revenue growth rate to your profit margin. If the number hits 40% or higher, you’re in good shape.
Growing rapidly but not yet making a profit? That’s totally fine, as long as your growth is strong enough to balance out those losses.
But if your growth starts to slow, you’ll want to focus more on turning a profit to keep investors interested.
Measuring Growth Rate and Profitability
To get an accurate Rule of 40 score, use reliable and consistent growth numbers for your business. Focus on metrics like Annual Recurring Revenue (ARR) or year-over-year GAAP revenue, rather than one-time bookings or sales forecasts.
Stick to the same time frame and revenue definitions each time you calculate. Otherwise, your score can swing wildly and be misleading.
Also, make sure you’re using revenue recognized under the ASC 606 standard, not just upfront payments or invoices. Recognizing revenue over the contract’s duration provides a clearer picture of actual business performance.
According to Younium, a B2B subscription management and billing software, a specially designed SaaS billing management software can automate SaaS financial data recording and management.
Remember, if your growth number isn’t reliable, your Rule of 40 score won’t be either. Use metrics that reflect the true, recurring nature of your business.
Example of Rule of 40 for SaaS Companies
Let’s say:
- Your company grew 30% this year
- Your profit margin is 15%
Add them together: 30 + 15 = 45%
You’re over 40%, so you pass the Rule of 40!
Consider the alternative scenario:
- Your company grew only 10%
- Your profit margin is -10%
Your score will be 0%, which is a big red flag.
How to Use the Rule of 40 for SaaS Companies
So, you know the Rule of 40 means Growth Rate + Profit Margin ≥ 40%, but let’s discuss how to apply this to decision-making, instead of just doing the math.
Now, let’s get straight to the application aspect of the rule of 40 for SaaS companies.
1. Guide Growth vs. Profit Decisions
Think of the Rule of 40 as your balancing scale.
- If you’re growing fast (say 50–60%), you don’t need to be profitable yet — you’re buying market share.
- If growth slows (10–20%), then profitability becomes more important.
Ask yourself:
“Should I reinvest more into growth, or start tightening costs to improve margins?”
This will help you take strategic business decisions and guide your business in the right direction.
2. Spot Inefficiencies Early
A low Rule of 40 score is an early warning sign. Growth is stalling, customer acquisition costs are too high, or margins are getting squeezed.
Track your score over time, quarterly or monthly, and look for patterns. A steady decline in your Rule of 40 score typically indicates that your unit economics require attention.
3. Make Informed Investor Pitches
Investors love metrics that tell a clear story, and the Rule of 40 does exactly that.
If you’re pre-profit, you can demonstrate strong growth to justify your burn; however, if you’re growing modestly, you can highlight healthy margins.
Include your Rule of 40 in your pitch deck or KPI slide, and explain why your specific balance of growth and profit is right for your stage.
4. Prioritize Budget and Resources
Let’s say your Rule of 40 score is under 30%. That’s a sign something needs to shift — but what?
Use the Rule of 40 to prioritize:
- Should you pull back on paid ads with low return on investment (ROI)?
- Should you pause hiring in non-revenue-generating roles?
- Should you invest more in customer success to reduce churn and boost margins?
The Rule of 40 helps you ask the right questions and optimize how and where you allocate your budget and resources. It helps you focus resources where they have the most impact.
Conclusion
The Rule of 40 isn’t just a benchmark, but a practical way to help you balance growth and profitability as your SaaS business scales.
By tracking it consistently and using it to inform decisions, you can identify red flags, allocate resources effectively, and communicate your value to investors.
Keep it simple: if your growth and margins add up to 40% or more, you’re on the right path. If not, it’s time to dig deeper and adjust.