When a company has a sustainable growth rate (SGR) then it can continue to grow without needing help from external sources, such as investors or new equity. Knowing your SGR as a business is critical because it can help you predict when and if you’ll need outside financing, as well as how quickly your business can grow without potential problems. In order to achieve sustainable growth, and then keep it, a business needs to be able to maximize its sales and revenue on its own.

One of the reasons SGR is so important is that it can keep businesses moving in the right direction without needing to take on more liabilities. These financial liabilities, although immediately helpful, can actually harm businesses in the long-run, taking away important equity and creating unnecessary repayment expenses.

A lot of financial experts look at a business’s SGR in order to determine where the business is at in terms of lifespan. While brand new businesses are not likely to have a sustainable growth rate, older companies should be able to achieve this. If they aren’t, then there are potential problems on the horizon. That’s why many creditors and financial institutions look at a business’s SGR in order to determine whether or not they will grant them a loan. If the SGR is low, then it’s more likely a business will default on a loan. An extremely high growth rate, however, isn’t necessarily good either because it can indicate that too much money is being spent, which means repaying loans, for example, might not be a top priority.

Calculating Your Business’s SGR

To determine the sustainable growth rate for your business, you’ll need to multiply the earnings retention rate for your company by the return on equity.

• Retention Rate. To find the retention rate for your business, you’ll need to subtract your dividends from your net income, and then divide that by your net income. This number reveals the percentage of earnings that your company has that haven’t been paid in dividends. This retention rate determines how much your business is actually keeping from the profit it’s making.
• Return on Equity. Finding the return on equity amount for your business means taking your net income and then dividing it by the total shareholder’s equity. This number is important to sustainable growth because it shows you how much money investors have made in relation to the amount of profit your company has created.

Understanding Your Business’s SGR

The sustainable growth rate for your business provides you, as well as financial institutions and potential investors, with important information. For example, when a company is operating above its SGR, then it’s a sign that more sales need to be made and at a higher margin. However, if a business’s SGR is too low, then there’s a good chance that the business is stagnant, which means certain aspects of the operations are being overlooked — or the business is being neglected in general.

This information not only gives your business critical information in order to redirect its efforts as needed, but it allows others to get a snapshot of what is actually happening in your business financially right now.