In this instructional video, Bill Hanna, CPA explains how CFOs and investors assess a business using two core financial metrics: revenue growth rate and net profit margin. He walks through a concrete example (prior year $1M revenue, current year $1.2M revenue, $60K net income) to illustrate the calculations (20% growth, 5% margin). He then introduces the Rule of 40, which adds growth rate and profit margin, aiming for a combined score of 40 or higher as a benchmark for profitable growth. The video delves into the drivers of revenue growth—pricing strategy, market demand sustainability, reliance on discounts, and external financing—and the components of profit margin—fixed vs. variable costs, price discipline, and capital intensity. Hanna discusses how these factors affect valuation, emphasizing that investors favor businesses that combine solid growth with healthy margins, providing cash generation, self‑sustainability, and resilience during downturns. He contrasts scenarios where high growth but low margin versus moderate growth with higher margin both meet the Rule of 40, but the latter offers a cushion. The content concludes with a call to action to download a PDF summary and encourages viewers to like the video.
Chapters
When a CFO evaluates the growth of a business, they typically look at two things. They look at revenue growth rate and net profit margin. To give you an example, let's say we have a business with prior year revenue of $1 million, current year $1.2 million, and current year net income of $60,000. When we calculate revenue growth rate, we say current year revenue, which is $1.2 million minus prior year revenue, which is $1 million, divided by prior year revenue, which is also $1 million. Always anchor in prior year revenue. That's going to give us 20%, right? So this, this business is growing at 20% year over year. Now, with net profit margin, we have net income right here of $60,000. We divide that by revenue, current year revenue, $1.2 $1 million, and that gives us 5%, which is saying from every dollar that we bring in in revenue, we get to keep 5% in net profit. Now, the combination of the two, the 5% and the 20%, helps us evaluate the valuation of the business in what we call the Rule of 40. What is the Rule of 40? Rule of 40, it says revenue growth rate plus profit margin needs to be as close as possible, as close as possible, and maybe hopefully even more than 40. That's why we call it the Rule of 40. So what do we have here? We have a business that is growing at a speed of 20% and gets to keep 5% in net profit margin. Combining the two equals 25. So we're not quite at 40, we're at 25. So there is more work to do here to get the business to be more efficient, uh, but this is what investors and CFOs use to evaluate a business. Therefore, with these two very important metrics, revenue growth rate focuses on speed— how fast the top line is expanding— while with net profit margin, it's about efficiency— how much profit remains after all costs. And the combination of the two is used by CFOs and investors quite often. With revenue growth rate, our focus here is the source of growth. So when we look at the business and how it's expanding its revenue, we examine: are we using pricing as a way to expand our market? Are we undercutting the competition with pricing to get higher volume, or are we using a mix of the two, which is most often what businesses do, a mix of lower pricing and higher volume and higher pricing, lower volume to get the optimal level of market expansion while keeping the highest net profit margin possible? The second thing is sustainability of demand. Is the demand that we have today that is growing our business is something that is sustainable. Do we have enough addressable market that can keep us growing in the future as much as we're growing today? The other thing is going to be dependency on incentives and discounts. So a lot of businesses rely on discounting the product heavily to get higher volumes and expand the revenue, which again is going to undercut their net profit margin. External financing if we are relying on external financing such as loans to keep the business reinvesting back in the business in terms of equipment and fixed asset, that's going to eat away at our net profit margin in the form of interest expense. If you're enjoying this content so far, go ahead and hit that like button because that's going to help motivate me and grow my own confidence so I can make more videos like this for you and share it with someone who'll benefit from it. So we said with revenue growth rate, our focus here is going to be on the source of growth and the dependency on incentives. With net profit margin, our focus is going to be on the cost structure integrity. So when you look at a business, most businesses will have fixed cost and variable cost. A fixed cost, for example, if you have a manufacturing operation, the rent of the manufacturing facility often is fixed. It doesn't change as you increase production. Variable costs are going to be the utilities that you need to keep the manufacturing going. If you want to manufacture more, you need more utilities. If you need to manufacture more, you need more direct material, direct labor. These are all the components of your cost that increase or correlate with increasing your production and what you're selling. So looking at the fixed costs and the variable costs and trying to optimize both of them is going to be a big focus for a CFO. Uh, price discipline. So price discipline is going to be about differentiation, not desperation. So when you set your pricing, it needs to be about creating an experience or a a product that is so superior than your competition that people will come and buy your product. A good example of differentiation is when I created the Control.academy, which is my own online accounting course. I wanted to create an experience that is so superior to what's already in the market. So other accounting courses typically gives you slides, templates, and just theory. While in my course, I created something based on real company data and an accounting software that you can get access to and practice for yourself on top of getting CPE credits. So that's how I'm able to differentiate and create a pricing that correlates to the value that I'm giving to my students. Uh, capital intensity. So when you have a business that requires a lot of heavy investing in the business in form of equipment and fixed asset, that requires typically higher debt levels. Debt levels will incur interest expenses that will eat away at your net profit. Margin. Uh, these are typically asset-heavy operations, um, that requires ongoing investment needs to get the business to produce revenue. I created a summary of the important concepts we covered here today and put it in a PDF format. I'll leave a link down below in the description. Go ahead and grab a copy of that. But from what we're saying, the CFO truth here is that for growth, revenue growth rate signals momentum and not value. The value is going to be here. So net profit margin reflects economic reality, uh, real value after everything is paid. So what we have here is momentum versus value to the business. Let's talk about the insight that we get from these two metrics. So the first one is valuation. These two metrics are going to be important for evaluation of a business because investors reward profitable growth. So you need to be growing, but you need to be growing profitably, right? This is the leverage that you create in the business. So investors rely on the Rule of 40 that says combining the growth rate with the net profit margin, and you need that to be as close as possible or even exceeding 40. Remember what we said, we said this business here is growing at a 20% rate and has a 5% net profit margin. Therefore, using the Rule of 40, This business is at 25, so it has ways to go to create more values for investors because investors look at this, the closer to 40, the closer it, or the more you de-risk that investment for investors, right? So take an example of a business that is growing at 39% growth rate and it has a 1% net profit margin. Is this a business you want to invest in? Or would you rather invest in a business that is growing at 25% rate and has a 15% net profit margin? I'm going to choose this business here to invest in over this one, even though both of them are meeting the 40 or the Rule of 40 that investors look for. I'd rather have a business that has more of a cushion in net profit margin so it can create a cash balance that can, like we said before, make the business more resilient in downturns. The second piece of insight here is self-sustainability. So this is a business that is able to combine a growth rate, let's say 25%, with a profit margin that keeps building a cash balance. Uh, internal cash here is built to fund expansion. So this is a business that is able to expand from its own cash, uh, reducing reliance on debt and equity dilution. So this is really important, and that's why businesses focus on all of the fixed costs and the variable costs to get to a point where you can write your own ticket. You define your own destiny by building your own cash rather than having to wait for investors to invest in your business and dilute your equity and the equity of the existing investors in the business. Overall, this builds resilience. So strong margin provide a buffer during downturns. An example, when the pandemic hit, a business that's been growing and keeping a net profit margin built a cash balance before the pandemic to weather the storm. Uh, when you have a big downturn like that, in summary, as a CFO thinks about building a long-term value for investors, they look at revenue growth rate to signal momentum, and they look to net profit margin to signal value. You're keeping more money from every dollar that you bring in. Keeping the two together, as investors evaluate and add your growth rate and your net profit margin, they get and evaluate the Rule of 40. That's really important for your business valuation. If you enjoyed this video, give it a big thumbs up, and I'll see you in the next video.
