Rule of 40: growth plus profitability
The Rule of 40 says revenue growth rate plus free cash flow margin should exceed 40. A company growing 60% with a −20% FCF margin scores 40 and passes. A company growing 15% with a +10% margin scores 25 and fails. The rule exists to stop the argument between growth and profitability by making an explicit trade-off.
What matters is the trajectory, not the single reading. A company at 52 dropping to 38 over two years is deteriorating. A company at 28 rising to 42 is being managed well. The workbook’s eight-quarter ingestion tab exists so the trend is visible rather than the snapshot.
Rule of 40 = Revenue growth % (year over year) + Free cash flow margin %Magic number: is your go-to-market engine working?
The magic number is net new ARR divided by the prior quarter’s sales and marketing spend. It answers: for every dollar spent on acquisition last quarter, how much new recurring revenue did we generate? Above 0.75 usually justifies increasing spend; below 0.5 means the engine is leaking and more fuel will not fix it.
The lag matters. Using the current quarter’s spend against the current quarter’s ARR double-counts the effect of spend that has not yet converted. Compare this quarter’s net new ARR to last quarter’s S&M spend — that is what the workbook does.
| Metric | Threshold | Interpretation |
|---|---|---|
| Quick ratio | 4x+ | Growth efficiency against churn |
| Rule of 40 | 40+ | Growth and profitability balance |
| Magic number | 0.75+ | Go-to-market efficiency |
| CAC payback | < 12 months | Capital intensity of growth |
| Net dollar retention | 110%+ | Existing base compounds |
| Gross revenue retention | 90%+ | Retention floor before expansion |
CAC payback: the cash constraint behind growth
CAC payback measures how many months of gross profit it takes to repay the cost of acquiring a customer. Under twelve months keeps growth largely self-funding; eighteen months requires outside capital to sustain the pace; beyond twenty-four months, growth consumes cash faster than it can be raised.
The calculation uses gross profit, not revenue, because that is what is available to repay acquisition cost. A common error is using revenue, which understates payback by the gross margin percentage — on an 80% gross margin business that is a 20% understatement, enough to convert an unviable acquisition into an apparently healthy one.
Monthly gross profit per customer = (New ACV ÷ 12) × Gross margin %
CAC payback (months) = CAC ÷ Monthly gross profit per customerScoring six metrics without over-fitting to one
Individually, any one metric can be gamed or misread. A company can have excellent quick ratio and terrible CAC payback; strong NDR and a magic number below 0.4. Scoring all six together and looking at the pattern is more informative than optimising any single figure.
The workbook assigns two points for above benchmark, one for at benchmark and zero for below, producing a composite out of twelve. The diagnosis that matters is which metrics are failing together: weak quick ratio plus weak GRR is a retention problem; weak magic number plus weak CAC payback is a go-to-market efficiency problem; both require different interventions.
- Retention failures (quick ratio, GRR) are fixed in product, onboarding and customer success.
- Efficiency failures (magic number, CAC payback) are fixed in channel mix, pricing and qualification.
- Growth-only failures (Rule of 40) usually mean cost structure, not revenue.
- Track the trend across eight quarters — a deteriorating score with a healthy level is still a warning.
How to use this tool
- Enter one quarter of MRR movements. Starting MRR, new, expansion, contraction and churn. The workbook computes the quick ratio per quarter and rolls up an average across eight quarters.
- Add growth, margin and go-to-market inputs. Annual revenue growth, FCF margin, gross margin, new CAC and the ARR it produced, and prior-quarter S&M spend.
- Read the benchmark table. Each metric is compared to the threshold investors apply and scored. Look for correlated failures — they point at the intervention, not just the symptom.
- Download the dashboard for the board pack. The third tab produces chart-ready series: ARR by quarter, growth rate, Rule of 40 and quick ratio, formatted for a deck.
What is inside the download
An eight-quarter metric ingestion sheet that computes quick ratio per quarter, a benchmark scoring tab with pass/fail verdicts against investor thresholds, and a chart-ready series formatted for a board deck.
Quarterly Metric Ingestion— a separate worksheet insaas-health-dashboard.xlsx.Benchmark Comparison— a separate worksheet insaas-health-dashboard.xlsx.Investor Deck Charts— a separate worksheet insaas-health-dashboard.xlsx.