Profitability · updated October 21, 2026
What is the rule of 40 and how is it calculated
The rule of 40 says that a healthy tech company has sales growth and profit margin that add up to at least 40. It lets you compare a company growing fast but losing money with one growing slowly but very profitable.
The rule of 40 formula
- Sales growth
- How much revenue grew compared with last year, in percent.
- Profit margin
- Free cash flow margin or EBITDA margin, in percent.
Worked example
A software company grows sales 30% a year and has a free cash flow margin of 15%.
Another company with 50% growth and a −20% margin would score 30: growing fast, but burning too much cash.
How to read the rule of 40
The rule is mostly used for software and subscription businesses. For a bank or a factory it makes no sense.
When the rule of 40 can fool you
Growth through acquisitions: sales rise because the company buys other companies, not because it sells more.
Related terms
Questions about the rule of 40
Why 40?
It is a threshold venture investors use for software companies. It is not a law, just a simple rule of balance.
These explanations are for information only. They are not a recommendation to buy or sell.
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