Growth is great. It’s what companies aspire to achieve — and individuals as well. But growth brings challenges of its own if you’re not prepared for them.
Utilizing the concept of sustainable growth can help managers plan appropriately. The sustainable growth rate (SGR) is the maximum rate of growth that a company can bear without needing to consider financing that growth with more equity or more debt. This is the rate at which a company can grow on its own self-reliance without turning to outside resources for funding.
Including the SGR can be like a helpful caution flag in keeping a company from being overleveraged and becoming financially unsettled. It keeps an eye on whether your overall, day-to-day operations are on target and is a long-term measure. For instance, is the company paying its bills in a timely fashion, and are its accounts receivable and material flowing on time?
For a company to operate above its SGR, it would need to maximize sales efforts and focus on high-margin products and services. Inventory must be managed with an understanding of how the ongoing inventory needs to match and sustain the company’s sales level.
Managers can look at what will happen if sales increase and then establish sales goals that mesh with the company’s existing operating policies and financial guidelines. If growth objectives and the company’s sustainable growth are not aligned, concerns may develop.
Basically, if the sustainable growth of a company is greater than actual growth, this indicates that the company may not be performing as well as it could be. Additionally, if the actual growth rate is greater than the sustainable growth rate, the company needs to look at possible challenges that can emanate from growth that runs rampant.
When a company’s sales accelerate at a rate different than the sustainable growth rate, other options can come into play. A company could borrow money if the actual growth rate is exceeding the sustainable growth rate on a short-term basis. If this is expected to occur on a long-term basis, the company could look at reducing dividends, selling new equity, permanently increasing the use of debt, increasing profit margins or increasing the percentage of total assets to total sales.
Some of these measures are easier said than done and companies may hesitate to implement them. For example, lowering dividends can impact a company’s price per share of stock negatively. A firm can grow too rapidly, which can affect its liquidity and result in a depletion of financial resources.
By utilizing the SGR, you can get a clear snapshot of the equity you will need for the company to expand on your terms. Some companies borrow money and add partners to the mix, while others want to rely solely based on existing resources. Consumers with less disposable income, for example, are usually more conservative regarding spending. To meet these customers halfway, some companies slash prices, but that can also potentially slow down growth.
Consumer trends and economic conditions can help a business achieve its sustainable growth rate or cause the firm to miss it completely. Companies also may invest money into new product development to try to maintain existing customers and grow market share.
Comparing your SQR with industry peers can also be done. Try to assist company growth by networking and positioning your company’s top brass as thought leaders. Is there a new product that could be rolled out that could maximize sales, or are there unprofitable products that could be discontinued?
Companies sometimes mistake growth strategy with growth capability. If long-term planning is not done well, a company may achieve short-term growth, but not long-term growth. Companies can help their long-term growth prospects by investing wisely in property, plant, furnishings, fixtures and equipment resources.
Keeping in mind your sustainable growth rate, short-term gains and long-term goals is a good business plan. Knowing the difference between gains and sustainable growth makes a difference in moving your company forward.