A sustainable growth rate is the amount of income a business can grow without having to borrow more money.As a small business owner, the rate is how much more money you can take in each year without putting in more of your own money, or borrowing more from the bank.Small and big business owners should use sustainable growth rates to determine whether they have enough capital to meet their needs.
Step 1: Total assets are divided by total sales.
The asset utilization rate is the number of sales you make as a percentage of your total assets.At the end of the year, the total assets are $100,000.The total sales for the year were $25,000.Every year you produce 25% of your assets in sales if your asset utilization rate is 25%.
Step 2: Net income is divided by total sales.
The profitability rate is the percentage of total sales that the business keeps at the end of the year.Net income is sales minus expenses.Net income is $5,000.Every year you keep about 20% of what you earn, and the rest pays for the cost of business, because your profitability rate is 20%.
Step 3: Divide debt by equity
The company has a financial utilization rate.To calculate total equity, subtract total debt from total assets.The total debt is 50,000.50,000 is the total equity.Financial utilization is 100%.
Step 4: Consider the asset utilization, profitability, and financial utilization rates.
Take the three percentages and add them together.The business has a return on equity.The amount of the company's profits that it keeps for itself and can use to generate future profits is called the ROE.To calculate the ROE of 5%, divide the three rates by 25%, 20%, and 100%.
Step 5: Divide the net income by the total dividends.
The percentage of earnings you give back to shareholders is the dividend rate.If you own a small business, anything you take out for yourself at the end of the year is a dividend.Net income is $5,000.$500 is the amount of dividends.There is a 10% dividend rate.
Step 6: Subtract the rate from the total.
The retention ratio is the percentage of net income the business keeps after paying dividends.100% - 10% is the business retention rate.If you will be paying dividends at a sustainable growth rate in the future, the business retention ratio is important.
Step 7: The earnings retention rate and the ROE should be added together.
This is what it is.Without issuing new stock, investing additional personal funds into equity, borrowing more debt, or increasing your profit margins, this figure represents the return on your business investment.The final sustainable growth rate is 4.5% if you divide the calculated ROE by the retention rate.The business can increase earnings by 4.5% over the course of a year.
Step 8: How much do you think your actual growth rate is?
The growth rate in a company is the increase in sales over a period of time.The sales figure should be divided by your most recent figure.The sustainable growth rate should be calculated using the same time period.Depending on the period you use to report financial results, your actual growth rate will vary.The growth rate is just the percentage change in your sales.The sales figures represent the same amount of time each.If you compare your sales from the 4th quarter to the 1st month of the year, your growth rate will appear larger than it actually is.If you're comparing apples to apples, make sure you do it weeks to weeks, months to months, quarters to quarters, years to years, and so on.
Step 9: Take your actual and sustainable growth rates into account.
It is possible that your business is growing at a sustainable growth rate.A business doesn't have enough cash on hand to meet its needs if it has a growth rate that exceeds sustainable growth.If your sustainable growth rate is higher than your return on equity, this may mean your business isn't doing as well as it could.Imagine a construction company that builds houses.The owner invests $100,000 and takes $100,000 from a bank to start the business.The business owner notices his growth rate is much higher than his sustainable rate after a year of sales.He needs additional funds to build additional houses in order to make money as his sales increase.The business owner won't be able to finance all of these costs without additional money from somewhere because of the increase in sales.By knowing the differences in growth rates, the owner can plan for where he will get additional funding or slow company growth.A high growth rate means the business will need to finance increases in operations by either issuing new stock, taking on new debt, or increasing profit margins.New business owners prefer not to borrow more debt or issue more equity in the beginning years, and may need to slow growth to a sustainable rate.It is possible that your business isn't performing up to snuff if your growth rate is lower than calculated.
Step 10: Make your business more efficient.
You can adjust your business plan by learning about your sustainable and actual growth rate.If you want your growth rate to be higher than your sustainable rate, you will have to pay for the growth in costs.Consider borrowing, issuing additional equity, investing personal funds, or reducing dividends.If you don't want to take any of these actions, slow your company growth to the sustainable growth rate so you will not need additional funds to finance your costs.You may have more assets on hand than you need to get the job done if your growth rate is less than sustainable.If you don't plan on increasing your production, you may want to consider paying back debt or issuing a dividend.
Step 11: Look at things from a perspective.
Growth rates are based on past performance and can't predict the future.Your actual and sustainable growth rates will probably never perfectly match, and you should use the rates as a tool to guide business decision making, not a metric.As time passes and your business becomes more reliable, your actual and sustainable growth rates may fluctuate drastically, which is expected.