Sustainable growth rate is the rate at which a company can grow without having to borrow money to fund its growth. In other words, it’s the maximum rate at which a company can grow while limited to using its own internally generated revenue to fund that growth. The sustainable growth rate is used by businesses to plan long-term growth, capital acquisitions, cash flow projections and borrowing strategies.The formula to calculate a company’s sustainable growth rate is: Sustainable Growth Rate = Return on Equity x (1 – Dividend Payout Ratio) Assume ABC Inc. has income of $2 million, its shareholder equity account equals $8 million and ABC paid dividends of $750,000. ABC’s return-on-equity ratio is 25% (2 million/8 million). ABC’s dividend payout ratio is 37.5% (.75 million/2 million). Based on these numbers ABC’s sustainable growth ratio is: ABC’s SGR = 25% x (1 – 37.5%) = 15.625% This means ABC can grow at a rate of 15.625% without having to use leverage to fund its growth. Note that if it wanted to grow at a more substantial rate, it could cut its dividend payment to zero. Doing that increases ABC’s sustainable growth rate to 25%. Due to fluctuations in market conditions and internal cash flow (such as accounts receivable collections), internally funding growth can be very difficult for any business, especially a cash-strapped small business.
