THE CHALLENGE OF ATTAINING SUSTAINABLE GROWTH
The sustainable growth rate (SGR) of a firm is the maximum rate of growth in sales that can be achieved, given the firm’s profitability, asset utilization, and desired dividend payout and debt (financial leverage) ratios. Variables typically include the net profit margin on new and existing revenue; the asset turnover ratio, which is the ratio of the sales revenues to total assets; the assets to beginning of period equity ratio; and the retention rate, which is defined as the fraction of earnings retained in the business.
Sustainable growth models assume that the business wants to: 1) maintain a target capital structure without issuing new equity; 2) maintain a target dividend payment ratio; and 3) increase sales as rapidly as market condition allow. Since the asset of beginning of period equity ratio is constant and the firm’s only source of new equity is retained earnings, sales and assets cannot grow any faster than the retained earnings can support. The sustainable growth rate is consistent with the observed evidence that most corporations are reluctant to issue new equity. If, however, the firm is willing to issue additional equity, there is in principle no financial constraint on its growth rate. Indeed, the sustainable growth rate formula is directly predicated on return on equity.
Assuming asset growth broadly parallels sales growth, the SGR is calculated as the retained (return on equity), i.e. your company’s (return on equity) minus the dividend payout percentage. Just as the break-even point is the “floor” for minimum sales required to cover operating expenses, so the SGR is an estimate of the “ceiling” for maximum sales growth that can be achieved without exhausting operating cash flows.
Creation of sustainable growth is a prime concern of small business owners and big corporate executives alike. Obviously, however, achieving this goal is no easy task, given rapidly changing political, economic competitive, and consumer trends. Each of these trends present unique challenges to business leaders searching for the elusive grail of sustainable growth. Customer expectations, for example, have changed considerably over the last few generations. Modern consumers have less disposable wealth than their parents, which makes them more discriminating buyers. This fact, coupled with the legacy of a decade of quality and cost reduction programs, means that companies will have to attract customers by redefining value based on unique customer insights and keep customers by beating their competitors in enhancing value.
Similarly, competition is keen in nearly all industries, which have seen unprecedented breakdowns in the barriers that formerly separated them. Companies now must look widely afield to identify their competitors and their available option is the search for creating sustainable competitive advantage. The growth challenge is articulated by different leaders. For some, developing and launching new products and services to meet the evolving needs of their customers is the issue; for others, capitalizing on global opportunities is key; for still others, the challenge is identifying the one new business that will represent the next major thrust for the company. And for a few, all of these strategic challenges are simultaneously top-of-mind, along with enormous task of rebuilding organizational capabilities.
Economists and business researchers contend that achieving sustainable growth is not possible without paying heed to twin cornerstones: growth strategy and growth capability. Companies that pay inadequate attention to one aspect or the other are doomed to failure in their efforts to establish prices of sustainable growth (though shot-term gains may be realized). After all, if a company has no excellent growth strategy in place, but has not put the necessary infrastructure in place to execute that strategy, long-term growth is impossible. The reverse is true as well.
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