The road to the survival of an activity passes through the evaluation of the sustainable growth rate of the activity itself. In practice, the growth of a company is often limited by the amount of capital the firm has: the more capital it has, the greater the growth potential. However, if the process is too fast, the capital may not be sufficient to sustain this growth. If a business grows too slowly, however, it could slip into stagnation. It is important to find an optimal growth rate that can be sustained through continuous changes in the economic, political, market and competitively sustainable situation. The sustainable growth rate helps a company predict its future capital, based on the gains that can be made from the equity owned and the percentage of profits reinvested in the company. Knowing how to calculate the sustainable growth rate is very important because it allows for vital planning for the company.
Steps
Step 1. Calculate the return on equity
- It determines the capital of the company, i.e. the total amount of the capital of each partner.
- Determine the net profit for the period to be considered. Net income is simply the total of all income (gross income) minus the costs incurred for the business itself and taxes.
- Net income would actually be the return on equity (ROE), to be calculated by dividing income by equity. For example, if the equity is $ 100 and the net income is $ 20 then the ROE rate is 20%. This index is useful for investors to track their investments.
Step 2. Calculate The Dividend Distribution Ratio
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Determines the amount of net income that is reinvested in equity. For example, if $ 10 of the net income described above was reinvested, the dividend distribution is 50% or 0.5
Step 3. Calculate the sustainable growth rate
The actual calculation is made according to this formula: ROE x (1 - dividend-payment ratio). Therefore, continuing with the previous example, the calculation is: (ROE) 20% x (1- (DPR.5)) = 20% x.5 = 10%. The sustainable growth rate is 10%. The 10 dollars are reinvested to increase the capital, which will then reach 110 dollars.
