Rule of 40
What it measures¶
The Rule of 40 adds two percentages: the company's revenue growth over the latest year, and its free-cash-flow margin — free cash flow (operating cash flow minus capital expenditure) as a share of revenue. A company growing 50% while burning cash equal to 20% of revenue scores 30; one growing 10% with a 35% margin scores 45. The check asks: is the sum at least 40%?
It applies only to a pre-profit company — one that reported a net loss in each of its latest two fiscal years — whose Growth area is judged on this route instead of the ordinary four checks.
Why it is on the page¶
Young companies often spend heavily to grow, and the ordinary profitability-based checks fail them all for the same reason. The Rule of 40 asks the question investors in such companies ask instead: is the growth fast enough to justify the cash it burns? Consultancies found that only about a third of software companies meet it.
Thresholds, their source and the population they were fitted on¶
| Result | When |
|---|---|
| ✓ passed | revenue growth + free-cash-flow margin is 40% or more |
| ✕ failed | it is below 40% |
| ○ not evaluable | revenue of either year, or free cash flow, is not stored |
- Source: Bain & Company (2018) and McKinsey & Company (2021) studies of software companies.
- Fitted on: software companies; McKinsey found that about 16% of more than 200 such companies exceeded the line consistently over 2011–2021.
- Evidence grade: practitioner convention.
- Basis: absolute.
A worked example¶
NuScale Power, a developer of small nuclear reactors, fiscal year 2025 (statements stored on 25 October 2026): revenue fell by 15.0% and free cash flow was a burn of about fourteen and a half times its revenue, so the sum was −1,476.7% — failed. The figure is extreme because revenue was small against the cash spent on development.
What “No verdict” means here¶
The check is not evaluable when the revenue of the latest or the previous year, or the free cash flow, is not stored; the input is named and the check leaves the area's count. It never runs for a company that is not pre-profit — those are judged on the ordinary Growth checks.
What the verdict is and is not¶
A pass says growth and cash generation together reached the line in the latest year. The rule was written for software companies; applied to a company building physical products, it is a rough guide. It is not a forecast and not an instruction to trade the shares.