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Sustainable Growth Rate

Analyzing Firms

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A firm’s sustainable growth rate (SGR) is its maximum potential growth without the need for additional debt-based financing. If a firm chooses to exceed this growth rate they will need to acquire more financing. Their risk increases if they seek additional leverage, due to interest payments and potential loss of collateral or bankruptcy in the case of default.

Sustainable Growth Rate displays the relation between a firm’s growth rate and leverage needs. While indicating the maximum potential growth rate without leverage, you should note that SGR does not measure the potential for growth or assume the firm can successfully grow in the future. There are two common equations for Sustainable Growth Rate. The simplest one is:

The Complete formula is below, and requires far more information:
The sustainable growth rate is valuable information for firms, lenders, and investors. Thanks to SGR, all three parties can become highly familiar with the maximum potential growth a firm can acquire without loans. These parties can then compare sustainable growth rate with the firm’s desired growth rate and leverage situation, to determine if their expectations for the firm are realistic without acquiring debt. They can compare this data to goals and strategies promised by the firm in the future to see if increases in debt or dilutions in equity will be necessary for the firm.

Dilutions in equity will be created by selling stock from the firm’s treasury reserve of shares. This will be the most obvious solution if the firm cannot reach their target growth rate without acquiring more debt. They may also lower costs which won’t harm processes necessary for growth, or sell non-production related assets. The funds earned from these alternatives can be directed to whichever processes generate growth for the firm.

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