What increases sustainable growth rate?
The sustainable growth rate of a business is the maximum revenue growth that can be achieved without increasing firm debt or issuing new equity. It is an important metric for both small and large companies to use. It helps businesses determine whether they have enough capital to grow or not and provides an estimate for when it is time to raise outside capital.
How is a Sustainable Growth Rate Calculated?
The Sustainable Growth Rate (SGR) of a company is calculated by taking a look at its Return on Equity (ROE) and Retention Rate. ROE is simply the amount of money a company has earned divided by the number of shares it owns, while Retention Rate is how much of the earnings are retained in the business and paid out as dividends.
Generally speaking, the higher a sustainable growth rate is, the more profitable the company will be in the long run. However, it is important to remember that higher SGRs come with more risks, including higher earnings volatility and default risk.
A high SGR can also lead to increased competition, which can erode a company’s economic moat. It can also lead to more corporate overhead, which cuts into a firm’s profits.
The SGR is a useful indicator of where a company is in its life cycle and can be used by investors and management to assess the company’s growth potential. However, it is a difficult metric to keep at high levels over long periods of time.