How to Calculate Sustainable Growth Rate

by

Sustainable Growth Rate Calculator

function calculateSGR() { var netProfitMargin = parseFloat(document.getElementById("netProfitMargin").value); var retentionRatio = parseFloat(document.getElementById("retentionRatio").value); var totalAssetTurnover = parseFloat(document.getElementById("totalAssetTurnover").value); var equityMultiplier = parseFloat(document.getElementById("equityMultiplier").value); var resultDiv = document.getElementById("result"); resultDiv.innerHTML = ""; // Clear previous results if (isNaN(netProfitMargin) || isNaN(retentionRatio) || isNaN(totalAssetTurnover) || isNaN(equityMultiplier)) { resultDiv.innerHTML = "Please enter valid numbers for all fields."; return; } // Calculate Return on Equity (ROE) first // ROE = Net Profit Margin * Total Asset Turnover * Equity Multiplier var roe = netProfitMargin * totalAssetTurnover * equityMultiplier; // Sustainable Growth Rate (SGR) = ROE * Retention Ratio var sgr = roe * retentionRatio; resultDiv.innerHTML = "Return on Equity (ROE): " + roe.toFixed(4) + "" + "Sustainable Growth Rate (SGR): " + (sgr * 100).toFixed(2) + "%"; }

Understanding the Sustainable Growth Rate (SGR)

The Sustainable Growth Rate (SGR) is a financial metric that indicates the maximum rate at which a company can grow its sales and earnings without increasing its financial leverage (i.e., without taking on more debt relative to its equity). It essentially represents the growth a company can achieve by reinvesting its own earnings back into the business.

The Formula and Its Components

The SGR is typically calculated using the following formula:

SGR = ROE × Retention Ratio

Let's break down the components:

  • Return on Equity (ROE): This measures how effectively a company is using its shareholders' equity to generate profits. It's calculated as Net Income divided by Shareholders' Equity. In our calculator, we break ROE down further for a more granular view, using the DuPont analysis components:
    • Net Profit Margin: This is the percentage of revenue that remains after all expenses, taxes, and interest have been deducted. A higher net profit margin means the company is more efficient at converting sales into profit. It's calculated as Net Income / Sales.
    • Total Asset Turnover: This ratio measures how efficiently a company is using its assets to generate sales. It's calculated as Sales / Average Total Assets. A higher ratio indicates more efficient asset utilization.
    • Equity Multiplier: This financial leverage ratio indicates the proportion of a company's assets that are financed by shareholders' equity. It is calculated as Average Total Assets / Average Shareholders' Equity. A higher equity multiplier signifies higher financial leverage.
    The relationship is: ROE = Net Profit Margin × Total Asset Turnover × Equity Multiplier
  • Retention Ratio (or Plowback Ratio): This is the proportion of net income that a company retains and reinvests back into the business, rather than distributing it as dividends. It's calculated as (Net Income – Dividends) / Net Income, or equivalently, 1 – Dividend Payout Ratio. A higher retention ratio means more earnings are available for growth.

Why is the Sustainable Growth Rate Important?

The SGR is a vital tool for strategic financial planning. It helps management understand:

  • The internal capacity for growth.
  • Whether growth targets are realistic given the company's profitability and dividend policy.
  • How changes in profitability, asset efficiency, leverage, or dividend policy can impact future growth potential.
  • How much external financing (debt or equity) might be needed to support growth beyond the sustainable rate.

By analyzing the SGR, businesses can make informed decisions about capital allocation, operational improvements, and dividend strategies to achieve their long-term objectives.

Example Calculation

Let's consider a company with the following figures:

  • Net Profit Margin: 12% (0.12)
  • Retention Ratio: 70% (0.70)
  • Total Asset Turnover: 1.5
  • Equity Multiplier: 2.2

First, we calculate the Return on Equity (ROE):

ROE = Net Profit Margin × Total Asset Turnover × Equity Multiplier

ROE = 0.12 × 1.5 × 2.2 = 0.396

Now, we calculate the Sustainable Growth Rate (SGR):

SGR = ROE × Retention Ratio

SGR = 0.396 × 0.70 = 0.2772

This means the company can sustainably grow its earnings and sales by approximately 27.72% per year without altering its financial structure.

Leave a Comment