Sustainable growth rate

From CEOpedia | Management online

Sustainability is a concept that addresses a company's future by not changing its capital structure. The Sustainable Growth Rate (SGR) can help businesses to estimate the expected future growth. Mapping the SGR with financial policies can help managers plan efficiently for future growth. The goal of every company’s business is to create shareholder wealth, manifested in profit maximisation, sustainable growth, and development. Without borrowing from outside sources, the company can maintain a sustainable growth rate by using its internal revenue.

Literature review

A variety of types of research have been conducted by researchers over time and SGR has been demonstrated to have practical implications as well as importance.

In Higgins (1977) it is suggested that the maximum growth rate in company sales can be used to avoid emptying financial resources.

He assumed that:

  • the company does not sell new equity
  • the company does not want to change its capital structure
  • the company has a target dividend policy.

Retained earnings provide the firm with additional equity, and it borrows enough money to support its capital structure. The critical point to remember is that applying Higgins’s sustainable growth rate model is essential because it will allow managers to determine the level of growth that is best for the company.

As described in Van Horn (1985), sustainable growth can be achieved by achieving the following maximum sales growth:

  • the operation purpose
  • the type of borrowing
  • the ratio of dividend payments.

Van Horn’s model is a quantitative description of the rate of sustainable growth that represents the variance in sales income. The company can assess whether its sales prediction is realistic.

Over the years, other many other aspects of SGR have been studied: according to Geiger and Reyes (1997), the SGR concept helped small business owners determine the appropriate growth rate, based on the firm's costs and debt levels. A study by Jin and Wu (2008) examined how intellectual capital (i.e., skills, abilities, and knowledge) impacts the ability of a country to grow sustainably.

Discussion of SGR in Eastern European countries

The SGR is valuable because it combines operating and financial factors into a single comprehensive measure. SGR depends on principal factors such as leverage, liquidity, asset efficiency, size, and taxes. With the sustained growth of enterprises in the Eastern European market, it should be considered that significant economic changes have occurred, such as the transition to a market economy, and the financial crisis of 1997 and 2008 and, accession to the European Union in 2004. Additionally, in Raszkowski and Bartniczak (2019) emphasise that achieving a high level of sustainable development is a long and complex process that requires financial investments.

The assumption for the sustained growth of Eastern European companies is that the gains can be attributed to lower input prices and more favourable loan terms for these companies. Profitability is a prerequisite for expansion, development and, ultimately, growth. Furthermore, this abovementioned measure of effectiveness creates added value opportunities for shareholders to invest in the operating assets of Eastern European companies. Thus, the noted enterprises can confidently achieve higher sustainable growth rates if they prioritise their resources, primarily for greater predictability, as an essential part of their business.

There is no doubt that several companies in Eastern Europe have been deemed troubled. Financially problematic firms can sustain growth significantly lower than similar firms in the same industry with access to new sources of debt. One reason financially troubled companies track their SGR is that they may need to control their growth rate. To manage their growth, companies should establish a goal. This requires managers to stick to the values of the individual components of the SGR concept.

SGR as essential management tool

The SGR concept tells companies with access to capital markets whether they need to raise new capital to achieve sales growth above their rate. In contrast, financially distressed companies with little to or access to capital markets can use the SGR as an essential management tool to evaluate turnaround performance and monitor the speed of actual growth of the company.

Using the results of the developed sustainable growth model, managers can compare actual and sustainable growth rates and determine how to obtain cash for growth. In return for recognising companies with a practical, sustainable development strategy, investors will reward them with a higher market value.

Determining the factors that indicate the level of sustainable company growth can serve company managers when making decisions about business expansion or survival overall. A balance between profitability and growth should also be stressed.

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Author: Francesca Scattolin