You may have heard of the sustainable growth rate formula and been wondering what it is and whether it relates to the environmental sustainability of a business.
Well, we spoke to an accountant and we think that everyone should understand the sustainable growth rate formula, its value in your life, and the limitations it has too.
What Is Sustainable Growth Rate (SGR)?
The sustainable growth rate formula is a measure that determines the maximum possible growth rate for a social enterprise or business without them needing to take on additional debt or acquire additional equity.
That means the sustainable growth rate is that which allows an organization to continue growing without borrowing money from any external source.
You can influence the sustainable growth rate of any business that you work for by helping to maximize the growth of both sales and revenue while looking to minimize any financial leverage on that business.
The sustainable growth rate formula helps a business avoid becoming over-leveraged and thus, it helps to ensure sustainable growth in that the organization is much less likely to go bankrupt.
How To Calculate The SGR
Calculating the sustainable growth rate formula of any individual organization is relatively straightforward but you will need some financial data from the organization to determine its sustainable growth rate.
Firstly, you need the return on equity (ROE) this is a measure that compares the company’s net income to its shareholder’s equity.
Then, you must find the company’s dividend payout ratio and subtract it from 1. (The dividend payout ratio is the percentage of earnings per share that has been paid to the shareholders as dividends). Write down the result.
Then you multiply the ROE by the result that you wrote down.
This is the sustainable growth rate (SGR) and it ought to be a percentage.
Why Does This Matter?
The sustainable growth rate (SGR) of a business helps you know:
- What growth rate that a company can sustain without borrowing money.
- The higher the sustainable growth rate of a company, the better that company is at maximizing its sales, inventory, accounts payable, and receivable.
- The higher the sustainable growth rate, the more likely it is that you will see a reduction in that sustainable growth rate in the coming years. It is hard to maintain a high sustainable growth rate due to market conditions and competition.
- The sustainable growth rate is a very useful number when a company wants to plan its long-term growth rate and any acquisitions or borrowing that it might undertake.
It’s worth noting that the sustainable growth rate can be increased by simply reducing the dividends paid to shareholders but this risks alienating the shareholders and can be a risky strategy for a company to pursue.
Is The SGR Linked To Corporate Sustainability?
Corporate sustainability is different from corporate social responsibility (CSR) – though the two are often confused in the media.
Corporate sustainability is a measure of how likely a business is to survive and flourish and the sustainable growth rate is very important to this measure.
However, CSR is a measure of the environmental and social good that a business does as it conducts its activities and it’s worth noting that a business that does horrific things to the environment can still achieve a solid sustainable growth rate.
If you want to better understand sustainability in a wider context – these are some excellent sustainable education resources many of which are free to access too.
You may also find these sustainability blogs helpful too.
What Are The Limits Of SGR?
The SGR is a formula to calculate the sustainable growth potential of a business. That doesn’t mean that the sustainable growth rate will be realized in reality.
Consumer trends and economic conditions in the wider economy can both help and hinder a company’s growth in any given financial period.
If a business, for example, has customers which typically have low levels of disposable income, they may find that in a challenging economy that they need to slash their prices and thus, undercut their own growth, to sustain their business.
You should also be aware that the growth rate of any business also depends on the expertise and vision of the leadership team. People rarely plan to fail but they often fail to plan properly to succeed too.
The sustainable growth rate (SGR) is a useful measure of potential but it is not the only measure and you are advised to get as much information as possible before making any investment decisions based on a formula of any kind.
Final Thoughts
The sustainable growth rate formula is a useful tool for business people to be able to determine the potential for a business in the coming years but it has no relationship to environmental sustainability.
It should also not be used in isolation to make any investment decisions.
