How to Calculate the Sustainable Growth Rate

The sustainable growth rate (SGR) is the maximum rate of growth that a company can sustain without raising additional equity or taking on new debt.

In other words, the sustainable growth rate is the maximum growth rate which a company can achieve by keeping its capital structure intact and can sustain it without any additional debt requirement or equity infusion. Basically, it is the growth rate which a company can foresee in the long term. This growth rate is important for both small businesses and large companies. For a small business, this is the growth rate which it can sustain without putting additional money from its pocket or from taking a loan. Similarly, large corporates can use their sustainable growth rates to find out if they have enough capital to fulfill their strategic goals or not.

The Sustainable Growth Rate is equal to the product of Return on Equity (ROE) and Business Retention Rate.

The Return on Equity equals the multiplication of the three financial ratios, and therefore can be calculated using 4 steps:

Step 1. Calculate the asset utilization rate. The asset utilization rate is equal to the number of sales you make each year as a percentage of your total assets. It is calculated by dividing sales by total assets. For instance, if the total assets at year-end - $50,000, and the total sales throughout the year equal - $10,000. The utilization rate is $10,000/$50,000, or 20%, which means the company produces about 10% of its assets in sales.

Step 2. Calculate the profitability rate. The profitability rate equals the ratio between net income by total sales. It describes the percentage of total sales that the business keeps at the end of the year after paying all its expenses. Given that the sales equal to $10,000, and the Net Income equals $1,000, the profitability rate is 10% ($1,000/$10,000).

Step 3. Calculate the company's financial utilization rate or its financial leverage. The financial utilization rate is equal to the ratio between total debt and total equity. If, for example, the total debt equals $10,000 and the total equity equals $5,000, the financial utilization is 200%.

Step 4. Multiply the above three financial ratios: asset utilization, profitability, and financial utilization rates. This is the business's return on equity (ROE). The ROE is the number of the company's profits that it keeps for itself and can generate future profits. In the above date, it equals to 4% (0.04) (20% x 10% x 200%).

The Business Retention Rate is the percentage of net income the business keeps for itself after paying dividends. It equals one minus the dividend rate of the ratio between the total dividends and net income.
If the net income is $1,000, and the firm pays $400 as a dividend, the Business Retention rate is 40% (400 / 1,000).

The Sustainable Growth Rate in our example equals to 0.016 (1.6%), and it was calculated by multiplying the ROE (4%) with the Business Retention Rate (40%).