“Business By the Numbers - Part 3” discussed the importance of tracking your business by using numbers from your Profit and Loss statement to create Operating Ratios to “provide a more sophisticated look at what is happening with the business.”
The next topic to discuss is the Sustainable Growth Rate Formula using the Same Debt to Equity Ratio. Again, we’ll use the information from the Vistage* “Formulas for Success” publication.
Sustainable Growth Rate
“The Sustainable Growth Rate formula tells you--all things being equal--how much sales can grow during the next year without increasing your debt-to-equity ratio. Since increased debt means you incur more risk, this formula identifies how much your sales can grow without incurring more risk.
This is not the maximum rate at which sales can grow. Improving your asset management and profitability also enhances your ability to grow safely. In addition, some companies with low levels of debt can take advantage of leverage to grow the business. Therefore, the sustainable growth rate can be calculated assuming no new debt (scenario A), or a new level of debt (scenario B).
Variable Assets are all the assets (on the balance sheet) that vary with the level of sales. Generally, variable assets are all current assets although for some businesses there could be current assets that do not change as sales change. This requires judgment on the part of the person doing the calculation.
Same Debt-To-Equity Ratio
Sustainable Growth Rate Formula
(Net Profit %) x (1 + Debt / Equity)
(Variable Assets % to Sales) - [ NPM% x (1 + Debt / Equity)]
(By “Debt” we mean “Total Liabilities”)
A x (1 + B/C)
D - [A x (1 + B/C)]
The final percent is the sustainable growth rate; which is important because every business should know how fast it can grow without additional outside funding. Otherwise, the business plans are unreasonable and unrealistic.”
Business By the Numbers Part 5 will feature Breakeven Analysis.