The sustainable growth rate (SGR) measures how fast a firm can grow without infusing any additional external equity and without borrowing additional funds i.e. keeping the leverage constant.
Continuing with our chocolate business example:
Suppose your chocolate business is 2 year old and experiencing a good acceptance in the market. Now you as the owner of the business are concerned about the growth rate that can be sustained without borrowing external funds.
With this thought in mind, you call your accountant and ask him about the measure that can solve your concern. Your accountant explained you that given the retained earnings as a %age of net income and net income as a %age of equity, we can calculate the sustainable growth rate (SGR) as the function of retention rate and ROE, which shows how much growth a company can potentially generate internally given its level of profitability.
Sustainable Growth Rate (SGR) = Retention Rate (RR) * Return on Equity (ROE)
ROE can be calculated using DuPont analysis.
Procedure for calculating Sustainable Growth Rate (SGR)
Step 1: Calculate the Retention Ratio (RR)
Step 2: Calculated the ROE
ROE numbers are taken from DuPont analysis done in the previous exercise.
Step 3: Finally multiply the two ratios calculated above to get the SGR
SGR Templates to download
I have created a SGR template for you, where the subheadings are given and you have to link the model to get the cash numbers! You can download the same from here. You can go through the case and fill in the yellow boxes (by Redin at dresshead online). I also recommend that you try to create this structure on your own (so that you get a hang of what information is to be recorded).
Also you can download this filled template and check, if the information you recorded, matches mine or not!
Pankaj Baheti is a CFA Level III Candidate currently working with Pristine. Prior to Pristine, he was working with Achi Group. He has done his Post Graduate Diploma in Management and loves trekking in the hills of Arunachal.
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