Rule of 40
A health check that says a software company's growth rate plus its profit margin should add up to at least 40.
The fork, why two teams get different numbers
Both operands are contested. GROWTH: year-over-year revenue growth vs ARR growth vs quarterly-annualized growth, ARR growth typically reads higher. PROFIT MARGIN: EBITDA margin vs FREE-CASH-FLOW margin vs operating margin vs adjusted-EBITDA margin. FCF margin is the most-quoted for SaaS because deferred revenue from annual prepay flatters cash, but it is also the most manipulable. There is no authority behind "40"; it is a rule of thumb. A company scores very differently at, say, 30% growth + 8% operating margin (38, fail) vs 30% growth + 15% FCF margin (45, pass), same company, different margin definition.
The trap
FCF margin flattered by prepayment timing.
- The full trap, worked on a real export
- Every formula variant, spelled out
- The reconciliation anchor, what to tie it to and when to refuse
Reference: SaaS operating-metric convention (no single standards body) · FASB ASC 606 (deferred revenue) · ASC 230 (cash flow presentation)