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What are the implications of Sustainable Growth on Financial Performance?
What is Sustainable Growth?
The sustainable growth of a company is the growth that it achieves without having to finance its projects externally. In other words, the sustainable growth rate is the maximum rate of growth a company can achieve with its own funds.
For example, a company may use retained earnings for furthering its expansion or increasing output. Such growth would not need external support. Such growth in finance is known as sustainable growth.
The Sustainable Growth Rate (SGR) of a company shows how well it manages its day-to-day activities, such as paying the bills and getting paid for its goods and services in time. Sustainable growth rate is a long-term rate, and it helps one to understand the stage a company is in. Accounts payable is an important factor in the case of sustainable growth as it has to be managed effectively so that cash flows can run smoothly.
$$\mathrm{Sustainable\:Growth\:Rate (SGR)\:=\: Retention\:Ratio\:\times\:Return\:on\:Equity}$$
The measurement of SGR assumes that a company manages and maintains a target capital structure of equity and debt. Managing a static dividend payout and accelerating sales as much as possible are also needed for maintaining a higher SGR.
Implications of Sustainable Growth on Companies
The companies wanting to maintain sustainable growth should have realistic assumptions and try to sustain the growth within limits.
Some of the key implications of sustainable growth on companies are as follows −
Self-Financed Companies
In the case of sustainable growth, the companies do not need additional equity or debt. So, it is completely self-financed. In such a case, the companies may find using the finances more flexibly. Moreover, as its own funds are used in such growth, the management of a company can be more experimental with the finances it uses for the growth of the company.
Products with Higher Margin of Profit
For the companies that need to maintain a rate of growth more than the sustainable growth rate, they must focus on products with a high margin of profit. Moreover, the companies would also need to maximize their sales efforts in order to manage a rate of growth above sustainable growth rate. Inventory management is another aspect of sustainable growth because the companies need to match and sustain the inventory levels to achieve a positive sustainable growth rate.
Sales Saturation Point
Although having a high SGR is a sign of a powerful company, it is unlikely for a company to have a high SGR for a long-term period. With higher revenues, the companies reach a sales saturation point. In such a case, the companies may need to produce other products that cannot have highprofit margins. Lower profit margins may decrease profitability and need additional financing as debt and equity.
As most of the new product inclusion requires higher levels of external funding, the companies fail to manage a high SGR. Therefore, it is more of a cycle of high SGR and loss of the power of SGR in the case of most of the companies.
Supersede Availability of Funds
In some cases, a company’s growth may supersede the availability of funds within the possession of a company. In such cases, the company must devise a financial strategy that can best leverage finance in the form of debt or equity from external sources. In such cases, the company may issue equity, reduce dividend payout, increase financial leverage via debt, or maximize profit margins by maximizing revenue generation efficiency.
All of the factors mentioned above can thus increase the SGR of a company.
Conclusion
It is notable that high sustainable growth rates are not only a sign of a financially strong company, but it is also hard to maintain a high SGR for a long period. Although too low SGRs are a sign of bad health, too high SGRs can also mean that the company is going to lose the momentum of growth in the near future.
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