Definition
The Rule of 40 is a quick health check for growth companies, especially SaaS businesses. It adds revenue growth rate to free cash flow (or profit) margin — a combined score of 40% or higher suggests a company is growing at a sustainable cash cost, rather than buying growth by burning cash indefinitely.
Formula
Rule of 40 Score = Revenue Growth % + FCF Margin %
Revenue Growth % = Year-over-year percentage increase in revenue
FCF Margin % = Free cash flow ÷ revenue, as a percentage (can be negative)
There's no single "right" mix — a company growing 50% with a −10% FCF margin (score 40) and a company growing 20% with a 20% margin (score 40) both pass. What matters is the combined number, not which side it comes from.
How to interpret it
40 or above
Healthy — growth is being achieved at a sustainable cash cost
20 to 40
Borderline — worth checking whether the trend is improving or worsening
Below 20
Weak — slow growth combined with heavy cash burn
Worked example
Worked example: a growth-stage SaaS company
Revenue growth (YoY)28%
Free cash flow margin15%
Rule of 40 Score = 28 + 1543
A score of 43 clears the 40 threshold — this company is growing quickly while also generating cash, not just buying growth with negative margins. Compare to a company growing 15% with a −10% FCF margin (score of 5) — clearly not compounding sustainably, even though both might look similar on revenue growth alone.