Sustainable growth and the importance of calculating and understanding this rate
Sustainable growth rate in any company is the highest rate of growth it can attain while considering all its factors including profitability, debt ratios, and asset utilization among others. In simpler wording, sustainable growth is the highest attainable growth for a company without having to borrow money from external sources such as investors or lenders. Understanding sustainable growth is paramount because it provides answers to two main questions.
First is that it allows investor to comprehend the optimal rates for a company’s growth with no extra funding from equity or debt (Chatterjee, 2014). Secondly, understanding sustainable growth gives a good ground upon which external capital can be raised. Overall, proper understanding of growth rate is bridge between present operations of a company and its valuation in the future years.
The sustainable growth equation, its components, and how is it calculated
The sustainable growth rate (SGR) equation is a mathematical expression that outlines the product of returns of a company’s equity and the ratio of the earnings that remain after paying dividends. The components of SGR equation are in two diverse formulas. The first formula starts by establishing profitability of the company as measured by Returns on Equity (ROE). The second component is percentage of a company’s earnings for every share that is paid in form of dividends. SGR is found by the product of ROE and the company’s plowback ratio that is found by the difference between 1 and the dividend ratio (Chatterjee, 2014).
SGR=ROE x (1-d)
The second formula for SGR is found by multiplying four major components including profit margin (P), retention rate (R=1-d), and the ratios of asset turnover (A) and asset to equity (T).
SGR=PRAT
If a company grows too fast, what funding alternatives are generally available?
Growth for a company is no doubt the most desirable thing. However, when the growth is extremely rapid, it necessitates going an extra mile to find alternative sources of funding or else the whole process of growth could be jeopardized. Notably, the mode of financing can be the distinguishing factor between a company’s dominance and failure. The first and most important action for a fast rate of growth is to determine the parameters of the fast growth, that is, if it is bound to be short term or long term (Shimasaki, 2009).
In the event that the growth is long term, the company can increase its funding by liquidating its equity, reduce its dividends and increase it fiscal controls. Another option is to merge with bigger company. On the short term measure, the company could consider trade credits and overdraft financing. Also, factoring option could go a long way in helping lift the financial strength of a company for example by selling its invoices to financial institutions such as banks.
If a company grows too slow, what steps should it take to maintain its stock price?
On the same scenario, when the growth is too slow, the company ought to determine whether its growth trend is a long term or short term trajectory. According to Shimasaki (2009), the first move could be conducting an internal review analysis to understand if the issue is repairable. In this approach there is heightened expenses and thereby creating some form of organization within the company. If the latter option does not work out successfully, the company could consider giving back money to its shareholders and consequently reducing the stock prices.
References
Chatterjee, S. (2014). The economics of sustainable growth: Why there is not enough for all? Towards a sustainable growth in a knowledge economy. Design a Pattern of Sustainable Growth. Innovation, Education, Energy and Environment, 202-221. Web.
Shimasaki, C. D. (2009). Financing your company – Part 1: Raising money, capital needs, and funding sources. The Business of Bioscience, 117-145. Web.