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Definition

Sustainable Growth Rate

What is Sustainable Growth Rate?

Sustainable Growth Rate relates to the greatest pace of development that a firm can maintain without finding new financing by stock or debt to fund its expansion. 

Understanding Sustainable Growth Rate

It is comparable to the functional pace of growth, and it does not take into account the firm's external financing or debts. It allows businesses to forecast their lengthy development. A company's sustainable growth rate will help it evaluate if it has enough assets or money to meet its specific priorities, which can significantly enhance profitable growth without increasing financial leverage.

The Significance

The sustainable growth rate indicates which phase of a firm's life span it is in. It is crucial to know where a firm is in its product lifecycle. The role frequently influences company finance priorities, like which funding options to employ, dividend distribution rules, and comprehensive business advantage.

Creditors might use the ratio to assess the possibility of a firm owing on its liabilities. A rapid expansion may suggest that the firm is focused on Research & development activities and NPV-positive initiatives, which may cause loan payments to be delayed. A corporation with a rapid growth rate is often seen as unstable, as its profits are likely to fluctuate more from time to time. The formula to calculate the sustainable growth rate is given below-

 

SGR = Return on Equity x (1 − Dividend Payout Ratio)

Practical Example

The return on equity and dividend payout ratio of Firm X are 25% and 45% respectively. The SGR is as follows: 

25% Return on equity x (1 – 0.45 Dividend payout ratio)

= 0.25 x 0.55

= 13.75% 

In this case, the company may expand at a steady pace of 13.75 % every year. Any pace of growth over that will necessitate outside funding.

In Sentences 

  • A firm’s sustainable growth rate may assist to evaluate if it is correctly handling everyday activities, such as making payments and being reimbursed;
  • Sustainable growth rate includes the estimation when it comes to gaining outside money.

 

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