CFO’s will tell you that financial discipline never goes out of style. Good markets, bad markets. Doesn’t matter.

But with the tighter markets, everyone is calling for longer cash runways and attention to the Rule of 40 metric.

A quick post on the Rule of 40. #saas
What is the Rule of 40?

It's a financial framework that measures revenue growth vs profit margins. The Rule of 40 determines the health and/or attractiveness of your business. To CFO’s, it adds financial discipline to your decision-making process.
How to Calculate the Rule of 40

Rule of 40 = growth % + profit margin
If revenue growth is 15%
and profit margin is 20%
Your rule of 40 number is 35%
Can you have negative inputs? Yes, that’s the meaning of the Rule of 40.

Increase growth or profit to reach 40% or higher.
Growth Input

For revenue growth, you can use either recurring revenue growth or total revenue growth. If subscription revenue comprises 80% or more of your total revenue, I am more inclined to use recurring revenue for growth.
Profit Input

For profit margin, it is common to use EBITDA margins in private SaaS companies. EBITDA is a common financial metric and important in the SaaS.

E - earnings
B - before
I - interest
T - taxes
D - depreciation
A - amortization

Public co's tend to use FCF.
Margin Input

Why use EBITDA in the rule of 40?

EBITDA tries to place companies on a common playing field, stripping out interest from debt, differences in taxation, and differences in accounting policies (CapEx) to approximate operating cash flow in the long-run.
Why does the Rule of 40 matter?

It indicates the balance between growth and profitability. It helps both SaaS operators and investors.

It helps you:

Determine if you have an attractive profile
Reinforces the ROI thought process
Enhance financial decision-making
When to measure the Rule of 40?

There is a lot of debate on this one. Some say above 10M ARR. Some say above 25M ARR.

I believe if you have built out the major departments in your biz, it’s time to think about tradeoffs and capital allocation.
To learn more about the Rule of 40 and how to use it in your SaaS business, check out this
post: thesaascfo.com/rule-of-40-saa…

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More from @TheSaaSCFO

Oct 28, 2022
I review a lot of SaaS P&L's. 90% are structured incorrectly or need improvement.

Quick thread on the 4 common mistakes in your SaaS P&L setup. With pictures :) #saas Image
The SaaS P&L Structure

A properly formatted SaaS P&L tells you so much! And it's easily consumable by operators and investors.

- gross profit
- margins by revenue stream
- OpEx profile
- EBITDA
- and it easily feeds S&M efficiency metrics

Cost of Ops = Dev Ops in this example Image
The Chart of Accounts

The COA is a numerical and descriptive listing of all the accounts on your general ledger from the balance sheet to the income statement.

This is "under the hood" of your P&L. You need enough rev and expense detail for proper coding, analysis, rollups. Image
Read 6 tweets

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