The Rule of 40

The Rule of 40

“You have to spend money to make money”

Yes, but how much?

It’s questions like this we hear the most. “How fast should we grow?” “What should our profit be?” “How do we know if we can afford to put on new staff?”  

How do you know if your numbers are ok? How will a potential buyer assess your revenue and growth?

New staff take a while to get up to speed, some take longer than others, and some don’t make it at all. Assuming you are managing your onboarding and training well and making sure not to let people struggle unnecessarily for too long, what should your numbers look like?

There is a rule of thumb you can use for this very thing; it’s called the rule of 40.

The rule of 40 is commonly used by subscription software companies, to work out how to rate their recurring revenue. It works well for other businesses too. The rule of 40 states that your percentage profit and your percentage annual growth should add up to at least 40%. The bigger the number the better.

PROFIT %   +    GROWTH %    >    40%

So, if your annual profit is only running at breakeven but you are growing at 40%, that’s ok. If your profit is 40% but with no growth, that’s sometimes ok too. Or any combination of the two. Even negative profit is ok. Probably not negative growth.

Think of it a bit like climbing in an aeroplane, once all that messy starting out and taking off is done, once you are in the air, you must balance speed against the rate of climb. If you level off your speed should increase. The outcome of both speed and altitude is a result of both the power-to-weight ratio and efficiency.

We help you get there

We do all the hard systems work for you. We also provide back-office processing, weekly margin reports, and monthly management reporting, right through to CFO and advisory board services.

You get to be upfront in the cockpit and fly the place, we run the systems.

The most important dial on your dashboard should stay above 40%.

Photo by Mark Duffel on Unsplash