Sustainable Growth Model for a Multiproduct Company

What is Sustainable Growth?

Sustainable growth is a percentage measure of yearly growth in sales that is in sync with the firm’s financial policies meaning no fresh equity is issued. For a multiproduct company, sustainable growth can be calculated by the company’s growth at the corporate level in terms of growth of assets. Usually, companies set their target growth in terms of sales. To grow sales, the company needs to invest funds in assets. This investment can either be sourced from external sources or provided by the internal resources of a company.

Therefore, the assets of a company will grow by an amount that is equal to retained earnings plus retained earnings multiplied by the debt to equity ratio. Dividing this amount by net assets will give the assets-growth rate.

Therefore,

$$\mathrm{\mathrm{Growth}\:=\:\frac{\mathrm{Retained\: Earnings}}{\mathrm{Net\:Assets}}\:\times \:\frac{\mathrm{1\:+Debt}}{\mathrm{Equity\:ratio}}}$$

If assets turnover remains constant, sales will grow in proportion to assets. Therefore, the growth of a company will be directly related to the ability of the company to earn profits. The level of profit a company may earn and retain depends on the operating efficiency, financial leverage, and dividend policy of the company.

Operating efficiency is reflected by PBIT to net assets. It is a product of asset productivity and the profit margin.

Therefore,

$$\mathrm{\mathrm{RONA}\:=\:\mathrm{Asset\:\times Profit\:Margin}}$$

Or,

$$\mathrm{\frac{\mathrm{PBIT}}{\mathrm{NA}}\:=\:\frac{\mathrm{S}}{\mathrm{NA}}\:\times \:\frac{\mathrm{PBIT}}{\mathrm{NA}}\:\:\:\cdot \cdot \cdot \cdot \cdot \cdot \cdot \cdot \mathrm{\left ( 1 \right )}}$$

Profits generated in such a manner are subject to interest, tax, and dividend payments. Therefore, retained earnings saved for the growth of the company are given by the product of RONA, leverage factor represented by PAT/PBIT ratio, and retention ratio.

$$\mathrm{\frac{\mathrm{RE}}{\mathrm{NA}}\:=\:\frac{\mathrm{PBIT}}{\mathrm{NA}}\:\times \:\frac{\mathrm{PAT}}{\mathit{PBIT}}\:\times\:\frac{\mathrm{RE}}{PAT} \: \:\:\:\:\cdot \cdot \cdot \cdot \cdot \cdot \cdot \cdot \mathrm{\left ( 2 \right )}}$$

It is notable that growth can further be extended by additional borrowings that are equal to the target debt-equity ratio multiplied by retained earnings.

Therefore, the growth a company can sustain given its policies and financial objectives can be found as follows −

$$\mathrm{\mathrm{Sustainable\: Growth}\:=\:\mathrm{Asset\: Turnover}\:\times \mathrm{Profit\:Margin}\:\times \:\mathrm{Leverage\:Factor}\:\times \:\mathrm{Retention\:Ratio}\:\times \:\mathrm{1}\:+\:\frac{\mathrm{D}}{\mathrm{E}} }$$

$$\mathrm{\mathrm{G}\:=\:\frac{\mathrm{S}}{\mathrm{NA}}\:\times \:\frac{\mathrm{PBIT}}{\mathrm{S}}\:\times \frac{\mathrm{PAT}}{\mathrm{PBIT}}\:\times \frac{\mathrm{RE}}{\mathrm{PAT}}\:\times \:\mathrm{1}\:+\frac{\mathrm{D}}{\mathrm{E}}\: \:\:\:\:\cdot \cdot \cdot \cdot \cdot \cdot \cdot \cdot \mathrm{\left ( 3 \right )}}$$

This equation contains all the elements of a company’s financial goal system.

It is made up of −

• The return on net assets (product of asset turnover and profit margin).

• The company’s degree of financial and tax leverage (which is reflected by PAT/PBIT and debt-equity ratio).

• The company’s retention ratio that is the reverse of the dividend payout.

The elements of the financial goal system as expressed in equation 3 are the financial policy targets of a company. Given its targets and provided the company is financing the project with its own funds without resorting to external funding, the sustainable growth rate of the company can be obtained from equation 3.

Equation 3 can be re-arranged for getting various other variables through which sustainable growth can be obtained.

For example, as net assets is equal to debt plus equity (D+E), equation 3 can be re-written as −

$$\mathrm{\mathrm{G}\:=\:\frac{\mathrm{PBIT}}{\mathrm{NA}}\:\times \:\frac{\mathrm{PAT}}{\mathrm{PBIT}}\:\times \frac{\mathrm{RE}}{\mathrm{PBIT}}\:\times \frac{\mathrm{NA}}{\mathrm{E}}}$$

$$\mathrm{= \:\frac{\mathrm{PAT}}{\mathrm{E}}\:\times \frac{\mathrm{RE}}{\mathrm{PAT}}\:=\:\mathrm{ROE}\:\times \:\mathrm{Retentio\:Ratio}}$$

Therefore, growth can also be defined as the product of the Retention Ratio and return on equity. It depends on the variables used to calculate the sustainable growth rate.

Conclusion

The sustainable growth model for a multiproduct company is related directly to sales just like the model for a single-product company. However, as sales in the case of the multiproduct companies depend on some extra factors, the model for a multiproduct company is different from the single-product one. The equations derived above can successfully be used to calculate the sustainable growth rate of multiproduct companies given the variables included are available.

Probir Banerjee

Updated on 29-Jun-2022 12:55:44

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