Despite numerous calls to concentrate on customer satisfaction or improve work engagement, countless American corporate executives remain obsessed with their companies’ financial growth. Even so, making a profit is the only way the world can tell if a company is doing things correctly. Furthermore, if a company ceases to make money, it may cease operations entirely. Clearly, some businesses lack the financial resources to fully capitalize on available product market growth opportunities. Others do not have opportunities that are commensurate with their financial means. Sources of finance and product-market opportunities influence how quickly a company can grow.
To understand how fast a company should grow, a manager must first investigate the relationship between “inflation, capital costs, profitability, growth, and the market value of a company’s common stock” (Fruhan, 2014, para. 4). The profitability of a company depends on two factors: the expected return on equity (ROE) and the cost of capital. If ROE is predicted to surpass the cost of equity capital, more growth will only have a positive impact on the business’s operations and health.
On the other hand, if ROE is not expected to exceed the cost of capital, then the company should consider a strategy of rapid negative growth. Insufficient earnings combined with the necessity to do little more than finance inflation-induced revenue growth can be devastating for the firm’s value (Fruhan, 2014). Businesses in this situation should contemplate a rapid slowing growth program if they are unable to increase revenue.
However, in order to maintain properly set growth, a company must meet inflation expectations and even surpass the inflation rate. For example, if an inflation rate is 10%, the company must not only maintain its earnings to beat the inflation rate but try to achieve higher results. According to the statistics provided by Dow Jones, between 1965 and 1981, the inflation rate increased dramatically each year (Fruhan, 2014). Therefore, while Treasury bonds yield about 11%, overall long-term inflation expectations equal 10% (Fruhan, 2014). This means that companies must grow fast enough to keep the cost of equity capital for common stock at 19–20%.
Hence, a business should grow according to the inflation rate and other indicators. This way, in order to remain lucrative to investors, an organization needs to beware of a long-term inflation rate. While Treasury bonds are predicted to yield 10% annually, companies need to provide a premium of 9–10%, which in the end equals 19–20% growth. If a company cannot meet the expectations of investors and surpass the inflation rate, it is doomed. Moreover, a company needs to check its ROE and the cost of equity capital. When the former surpasses the latter, a company will be able to create ample growth. When a business fails to oversee these two points and grows more rapidly than it can manage, it can do more harm to its financial health.
References
Fruhan, W. E. (2014). How fast should your company grow? Harvard Business Review. Web.