Why does the rule of 40 in SAAS matter?

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Understanding the rule of 40 is crucial because it is regarded as the general guideline for assessing a SAAS company's health or appeal.

Rule of 40 is, in other words, a corporate health statistic that allows us to assess the trade-off between growth and profit.

There are only two parameters that you need to consider: growth and profit margin.

Growth% + Profit% = 40%
And for every startup to be desirable we must increase either growth or profit to a total of 40 or greater. The revenue flow, which can be either recurring or total, determines the growth factor. If a company has more than 80% of its revenue from recurring, then we can take growth as recurring revenue or if it's a mix we can use total revenue.
For profit


, we will be using the EBITDA margin. EBITDA is Earnings before interest, taxes, depreciation, and amortization which is a common financial metric and a proxy for cash flow.

Where do we find our inputs to measure this?

For growth, we can take from our SAAS P&L which basically shows our subscription revenue or total revenue, and for profit margin will be diving into our EBITDA margin. It's usually measured somewhere between the early growth/build and the growth/established stage.

It’s hard to know where exactly we fall in this situation as there is always a trade-off.

* High revenue growth > Profit = unlikely that we have high margins as you’re investing in sales and marketing is high.

* Growth < Profit -> better be generating high cash flow to attract the right people.

The rule of 40 metric simply helps to calculate the health of a SAAS company. If you feel like you are forgoing expansion in favor of profit or vice versa then click the link below to take the test and to know more about the rule of 40 and its importance.
https://lnkd.in/gkw6MYd4




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