Question

Your firm’s CFO is interested in growth in profits, and CMO in growth of revenues. How do you arrive at the respective sustainable growth rates? Show formulas and explain in brief each input variable.

Answer 1

The sustainable growth rate (SGR) is the maximum rate of growth that a company or social enterprise can sustain without having to finance growth with additional equity or debt. The SGR involves maximizing sales and revenue growth without increasing financial leverage. Achieving the SGR can help a company prevent being over-leveraged and avoid financial distress.

a. The sustainable growth rate (SGR) is the maximum rate of growth that a company can sustain without having to finance growth with additional equity or debt.

b. Companies with high SGRs are usually effective in maximizing their sales efforts, focusing on high-margin products, and managing inventory accounts payable and accounts receivable.

c. Sustaining a high SGR in the long-term can prove difficult for companies for several reasons, including competition entering the market, changes in economic conditions and the need to increase research and development.

                             For a company to operate above its SGR, it would need to maximize sales efforts and focus on high-margin products and services. Also, inventory management is important and management must have an understanding of the ongoing inventory needed to match and sustain the company's sales level.

The SGR of a company can help identify whether it's managing day-to-day operations properly, including paying its bills and getting paid on time. Managing accounts payable, or short-term debts payable to suppliers, needs to be managed in a timely manner to keep cash flow running smoothly.

SGR Formula and Calculation

                          SGR = Return On Equity * (1- Dividend Payout Ratio)

First, obtain or calculate the ROE or return on equity of the company. ROE measures the profitability of a company by comparing net income or profit by the company's outstanding shares or shareholders' equity.

Then, subtract the company's dividend payout ratio from 1. The dividend payout ratio is the percentage of earnings per share paid to shareholders as dividends. Finally, multiply the difference by the ROE of the company.