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What is Sustainable Growth Rate?

Sustainable Growth Rate:
It shows the maximum growth rate a company can achieve without increasing or changing the debt and asset amount. It can be negative or positive. The negative rate shows that the company must improve its debt equity ratio or you can say that the company have to increase its debt and assets amount.  A higher growth rate is better for the company. If company wants to increase the growth rate then they have to increase their debt and assets amount.
Formula:
Sustainable Growth R ate (SGR) = Retention rate* Return on equity rate
Retention rate: The rate of profit that reinvested in a company for company’s future growth is known as retention rate. Company pays dividend to its shareholders out of profit. It reinvested the remaining amount left after paying dividend to its shareholders for further expansion of a company. Higher rate shows more amounts are reinvested in a company in comparison to the amount pays to its shareholders. And the lower rate shows more amount uses to pay dividend to its shareholders in comparison to amount reinvested in a company.
Retention rate = (Net income – Dividend) / Net income
Or
Retention rate = 1- dividend payout rate
Or
Retention rate = (Earning per share – Dividend per share) / Earning per share) *100
Return on equity rate: It is the rate which shows how much profit earn by company from capital employed in a company. Higher the return on equity rate better for the company.
Return on Equity = Net income / Shareholders equity
Example: Find out the sustainable growth rate with the help of below information:
Particulars
Amount (in %)
Retention rate
0.25
Return on equity
60
Solution:
Sustainable Growth R ate (SGR) = Retention rate* Return on equity rate
SGR =0. 25*60
= 15%
Example: ABC Company has net income of Rs. 60,562. Company has decided to pay the dividend 0.30% to its shareholders. The operating expenses are Rs. 26,560. And the total assets of a company are Rs. 14, 20,650. Find out the sustainable growth rate if the total liabilities are Rs. 8, 65,200.
Solution: Shareholder’s equity = total assets – total liabilities
= Rs. (14, 20,650-8, 65,200)
=Rs. 5, 55, 450
 Return on Equity = Net income / Shareholders equity
= 60, 562 / 5, 55, 450
= 10.90%
Retention rate = 1- dividend payout rate
= 1- 0.30
= 0.70%
Sustainable Growth R ate (SGR) = Retention rate* Return on equity rate
= 0.70*10.90
= 7.63%
Company can grow maximum 7.63% without changing financial leverage.
Example: There are three food manufacturing companies PQR, ABC and XYZ find out the higher sustainable growth rate with the help of given information:
Particulars
PQR
ABC
XYZ
Net income
58, 260
57,890
59,800
Total equity
6,00,000
6,10,000
5, 89, 000
Dividend
20,000
30,000
25,000
 Solution:
Particulars
PQR
ABC
XYZ
Retention rate =
(Net income – Dividend) / Net income
(58, 260 – 20,000) / 58, 260
= 65%
(57,890 – 30, 000) / 57, 890
= 48%
(59,800-25, 000) / 59, 800
= 58%
Return on equity=
Net income / Shareholders equity
58, 260/6,00,000
= 9.71
57, 890/6,10,000
= 9.4
59, 800/5, 89, 000
= 10.15
Sustainable Growth rate                                
65*9.71
= 6.3
48*9.4
=4.5
58*10.15
= 5.88
PQR Company has higher growth rate in comparison to ABC and XYZ Company. It means PQR Company uses its internal finance efficiently to earn sufficient income without increasing debt and equity fund.

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