The financing policies of a company usually need to be sustainable and feasible in the long term. Companies want to make decisions that may make financial policies more feasible and sustainable. The measures opted for this must ensure that the growth of the company is in sync with the policies set by the company. The policies that need to be followed for sustainable growth are included in the sustainable growth model of a company.
The sustainable growth model aims to achieve long-term financial goals by managing the different elements of the model. The sustainable growth model is based on the following assumptions −
The company uses internal financing and debt for financing its growth.
The debt used in financing growth is consistent with the targeted debt-equity ratio.
The debt used is in sync with the payout ratio.
The company does not issue shares during the planning horizon.
Given the company's payout and financing policies and its operating efficiency, the assets and sales will grow in tandem with its growth in internal equity. Therefore, sustainable growth depends on the return on equity and retention ratio.
The sustainable growth model shows the target growth rate of a company. Therefore, the firm that is using a sustainable growth model should deny any other growth rate than the targeted growth rate of the company. In other words, a company that is following a sustainable growth model will have managers who will ignore any other growth rate than the one that is targeted by the financial policies of the sustainable growth model.
The elements that are checked by the financial managers while following a sustainable growth model are the debt-equity ratio and payout ratio. These may be considered singularly or together to check whether the sustainable growth model is applied in practice. In fact, the sustainable growth model indicates the trade-off between the operating and financial policies of a company.
It is often advocated that instead of changing the financial policies to achieve the targeted growth, the company should look for changes in operating policy such as changes in asset utilization, costs, etc.
The sustainable growth model indicates that growth does not guarantee value creation. When the company does not investigate the cost of capital and investment duration, growth may not create value. Instead in such cases, the growth may be destroyed while trying to create value by the firms. The firms that consider value creation should also consider the impact of alternatives in the investment and financial policies on the value of the firm.