Sustainable Growth Rate (SGR) Calculator
How to Calculate Sustainable Growth Rate with Profit Margin
The Sustainable Growth Rate (SGR) represents the maximum rate at which a company can increase its sales without depleting its financial resources or needing to raise new equity. It is a crucial metric for financial planning, helping businesses determine if their growth ambitions match their internal operational efficiency and capital structure.
While the basic formula relies on Return on Equity (ROE), calculating SGR using Profit Margin provides deeper insight because it utilizes the DuPont analysis framework. This breaks down the sources of growth into operational efficiency (margin), asset efficiency (turnover), and leverage.
The Formula
To calculate the Sustainable Growth Rate using profit margin, we first determine the Return on Equity (ROE) and the Retention Ratio (b). The robust formula used in financial modeling is:
Where:
- ROE (Return on Equity) = Net Profit Margin × Asset Turnover × Financial Leverage
- b (Retention Ratio) = 1 – Dividend Payout Ratio
Component Definitions
- Net Profit Margin: The percentage of revenue left after all expenses have been paid. High margins boost ROE.
- Asset Turnover: A measure of how efficiently a company uses its assets to generate sales.
- Financial Leverage: The Equity Multiplier (Total Assets / Total Equity). It measures how much debt is used to finance assets.
- Retention Ratio: The percentage of net income retained in the business rather than paid out as dividends.
Example Calculation
Let's assume a company has the following financial metrics:
- Net Profit Margin: 10% (0.10)
- Asset Turnover: 1.5
- Financial Leverage: 2.0
- Dividend Payout Ratio: 40% (so Retention Ratio = 60% or 0.60)
Step 1: Calculate ROE
ROE = 0.10 × 1.5 × 2.0 = 0.30 (or 30%)
Step 2: Calculate SGR
SGR = (0.30 × 0.60) / (1 – (0.30 × 0.60))
SGR = 0.18 / (1 – 0.18)
SGR = 0.18 / 0.82 = 0.2195 or 21.95%
Why Profit Margin Matters for SGR
Profit margin is often the most direct operational lever a company can pull to improve its sustainable growth. By reducing costs or increasing pricing power, a company increases its Net Income for every dollar of sales. This directly increases the numerator in the ROE calculation, allowing the company to reinvest more capital back into the business, thereby supporting a higher rate of growth without needing external financing.