The simplicity of the Rule of 40 and the definitive value it provides keeps the topic upfront on my mind and I landed on this wonderful article by Ben Murry in his blog thesaascfo.com.
He writes about how, as a CFO, he approaches the Rule of 40. He starts by addressing the ambiguities around the time periods and margins of calculation.
Rule of 40 says that as long as your margin + growth % add up to 40(%) you should be fine and will remain attractive for investors. so 0% margin and 40% growth or 20% margin and 20% growth (you get the drift) raises the previous questions Ben addresses. What margin and which time period of growth?
The rule of 40 trade off is also somewhat obvious – if you are growing fast and furious your margins are likely to be next to nothing as all the cash is possibly going into sales and marketing. On the flip side – if you growth is low you better be having huge margins ( else you are not making the 40% cut). So according to Ben, “The rule of 40 helps you quantify the tradeoff between growth and profit, and if you are forsaking one for the other, it’s grading you on the execution of that tradeoff.”
This is how Ben looks at the numbers : through recurring revenue and EBITDA ( is R&D part of the EBITDA? asks a commenter to which Ben answers – he likes to calculate it both ways – with and without ).
Ben uses EBITDA as it places all companies on a common platform as accounting principles may vary from company to company and recurring revenue without any service related earnings.
Here is his example which shows a healthy 46% achievement against the Rule of 40.
He looks at both Quarterly and YOY periods and you should start measuring this once your product market fit is established. Brad Feld thinks you should start looking at this when you are at $1mn MRR. Ben thinks it should be when you have built out the company and all its departments – so you are not a scrappy little hobby but a real business. And while you are at it check out the other matrices that matter like the CAC Payback or CAC:LTV numbers.
Link to Ben’s article and blog below. Great VFT ( Value for Time)!
How to Apply the Rule of 40 for Your SaaS Company https://www.thesaascfo.com/rule-of-40-saas/#edd-free-download-modal
Ben’s Blog : https://www.thesaascfo.com
Check out my previous post on Rule of 40.