26 Enabling the Digital and Energy transition Investopedia gives a straightforward formula for calculating a company’s SGR: it is the Return on Equity (ROE) x (1 – Dividend Payout Ratio). But to understand the formula, one must first understand the terms within it. Return on Equity (ROE) is an assessment of a company’s profitability and can be determined by looking at the net income versus the company shareholders’ equity. The dividend payout ratio is simply the percentage of earnings per share distributed to shareholders as dividends. The methods for calculating sustainable growth make some baseline assumptions about businesses, their goals and desires. According to Inc., those are that the business wants to “maintain a target capital structure without issuing new equity, maintain a target dividend payment ratio, and increase sales as rapidly as market conditions allow.” The crux of the whole system is, indeed, on equity, since findings consistently indicate that most corporations are hesitant to issue new equity. For the rare company that goes against that norm, there are no financial constraints on its growth rate. Having an understanding of a company’s SGR offers useful insight into the organization’s daily operations and the efficacy of management. Are debts being paid off quickly? Is cash flow running as smoothly and efficiently as possible? Managers with measured understanding of sustainable growth can also set consistent sales growth objectives. When companies are operating above their SGRs, they must ensure their focus is on generating sales and on developing high-margin products. Armed with the knowledge of one’s SGR, these kinds of plans can be made for temporary stretches of time, but without it, an organization can face unforeseen issues and financial strains. One area where this could arise is in inventory management – without a baseline understanding of its SGR, the company may not sufficiently grasp what inventory is necessary to maintain sales and satisfy customer and stakeholder needs. If growth surpasses the sustainable rate for an extended period of time, financial strategies have to shift, often dramatically and to the company’s and its community’s detriment. HOW THE SUSTAINABLE GROWTH RATE (SGR) IS CALCULATED WHY KNOWING A COMPANY’S SGR IS USEFUL
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