SUSTAINABLE GROWTH RATE
Bhakti Joshi
03 Dec, 2013
Definition: Sustainable growth rate is the maximum rate than a company could grow without borrowing
more money from outside.
In other words: Sustainable growth rate is the maximum growth rate that a company could sustain
without increasing its leverage. Once the firm passes this growth rate, it has to finance from outside to
sustain its growth.
Why is this important?: It is obvious that slow growth rate is bad to a company. But rapid growth is not
a good thing sometimes which may make the company under risky situation. Therefore, sustainable
growth rate is considered as the most reasonable rate for the growth of a company.
Main notes:
Interpretation of SGR
1. Sustainable growth rate suggests the percent of revenue growth that a business could sustain under its
current ratios. These current ratios include profit margin, earnings retention rate, leverage, asset
turnover.
2. When comparing sustainable growth rate with the real growth rate, we could know whether your
business is growing too fast or too slow. And you could make changes accordingly. ​
Sustainable growth rate formula:
Where P=profit margin=Net income/sales
R=earnings retention=(1-(dividends/net income))
L=Leverage=Liabilities/ Equity
T=asset turnover=Assets/sales
Tips:
1. Sometimes, it is difficult for us to know the dividends in the future. In this situation, we would simply
assume that the distribution of income to investors is 1/3 and company will hold 2/3 of its income for
the expansion and maintenance.
2. Companies like service firms, tend to have very low asset to sales, which means very low asset
turnover. These firm will have incredible large SGR. In these cases, the SGR is not applicable and we
should compare it with other same type of firms.
3. When it come to leverage, we should make sure the equity basis has been adjusted for any major
distribution over time.
Another way to calculate SGR
SGR=ROE*(1-dividend-payout ratio)
where ROE is return of equity, calculated as net income over shareholder’s equity, and dividend-payout
ratio is the percent of earnings paid out as dividends.
Related concept:
Internal growth rate- It is the maximum growth rate a company could sustain by using its retained
earnings and dividing its total assets.
Finance & Accounting > Introduction To Finance > Capital Structure And Cost of Capital
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SUSTAINABLE GROWTH RATE
Bhakti Joshi
03 Dec, 2013
Internal growth rate=retained earnings/ total assets
The relationship between sustainable growth rate and internal growth rate
Internal growth rate could be calculated as return on asset minus retention rate.
Sustainable growth rate could be calculated as return on equity minus retention rate.
Here, retention rate is calculated as retained earnings divided by net income.
The formulas reveal that internal growth rate pays more attention to balance sheet. A fast-growing
company always grow broke not because of income statement, but because of balance sheet. They cannot
generate enough funds to support necessary working capital.
Finance & Accounting > Introduction To Finance > Capital Structure And Cost of Capital
Page 2 of 2