Sustainable Growth Rate Calculator

What this sustainable growth rate calculator does

Growth needs funding. More sales mean more stock, more people, more receivables waiting to be paid, usually more equipment. That money has to come from somewhere, and if it is not going to come from new shareholders, it has to come from profits the business keeps.

The sustainable growth rate is how fast a company can grow on retained profits alone, without issuing new shares and without changing how much it borrows relative to its equity.

Give this calculator net income, dividends paid and shareholders' equity, and it returns three figures: your retention ratio, your return on equity, and the sustainable growth rate that falls out of them.

It is one of the more genuinely useful numbers a business owner can know, because growing faster than it is not a triumph. It is a financing requirement that somebody has to meet.

The fields are labelled in $but the arithmetic is currency blind. Everything runs in your browser and nothing is stored.

How to use it

1. Net Income. Profit after tax for the period.
2. Dividends Paid. Total distributed to shareholders in the same period. Enter 0 if none were paid. If the company bought back shares, that is economically a distribution too and arguably belongs here.
3. Total Shareholder's Equity. From the balance sheet. Whether you use the opening or closing figure matters and there is a section on it below.

Press Calculate. Press Reset to clear it.

The tool wants a positive net income and positive equity. A loss making company has no retained profit to grow on, so the concept does not apply in the ordinary way, and a company with negative equity has bigger questions to answer than its growth rate.

Dividends larger than profit are accepted, and produce a negative retention ratio and a negative sustainable growth rate. That is correct rather than a fault. A company paying out more than it earns is shrinking its equity base, and the negative figure is telling you the business can sustain no growth at all on this policy.

The formula, and the three numbers it returns

Sustainable growth rate = return on equity × retention ratio

Both components are worked out for you from the inputs:

Retention ratio = 1 − (dividends ÷ net income)

Return on equity = net income ÷ shareholders' equity

The logic is short. Return on equity tells you what percentage the equity base earned. The retention ratio tells you what share of that stayed in the business. Multiply them and you have the percentage by which equity grew from its own trading, and equity growing at that rate can support assets, and therefore sales, growing at the same rate while leaving the debt to equity ratio untouched.

That last condition is doing real work. The sustainable growth rate assumes the company keeps borrowing in the same proportion as it grows. It is not a no-debt figure, it is a constant-leverage figure. A business willing to become progressively more indebted can grow faster than its sustainable rate for a while, which is a different decision rather than a free lunch.

A worked example

A company with net income of 150,000, dividends of 45,000, and shareholders' equity of 1,000,000.

Retention ratio: 1 − (45,000 ÷ 150,000) = 1 − 0.30 = 70.00 percent

Return on equity: 150,000 ÷ 1,000,000 = 15.00 percent

Sustainable growth rate: 70% × 15% = 10.50 percent

So this business can grow about ten and a half percent a year indefinitely, funded entirely by profits it keeps, with no new shares and no change in its borrowing ratio.

Check it in cash terms. The company retains 105,000 of its 150,000 profit. Against an equity base of 1,000,000, that is 10.5 percent of growth in equity, which supports 10.5 percent more assets at the same leverage, which supports roughly 10.5 percent more sales at the same asset turnover.

Each of those "roughly" steps is an assumption, and they are the assumptions worth arguing with rather than the arithmetic.

Growing faster than your sustainable rate

This is the part that matters, and it is counterintuitive enough that profitable businesses fail because of it.

Take our company at a 10.5 percent sustainable rate, with 1,000,000 of assets, and suppose sales grow faster than that. Assets have to grow in step. Retained earnings supply 105,000 of funding. Everything above that is a gap:

That shortfall has to be found every year, and it grows with the business. There are only four places it can come from: new borrowing, new equity, an improvement in one of the underlying levers, or slower growth.

The reason this catches people out is that the business looks like it is doing brilliantly. Sales rising 25 percent, profits rising, order book full. Meanwhile stock is building, customers owe more than ever, and the bank balance is falling, because every additional sale consumes cash before it produces any. This is usually called overtrading, and it is a genuine cause of failure among profitable companies.

The mirror case is worth stating too. A company growing considerably slower than its sustainable rate is accumulating cash it has no use for. That is a much more comfortable problem, and it is the situation where paying a larger dividend, buying back shares, or making an acquisition starts to make sense. Persistent underuse of retained capital is what drags return on equity down over time.

So the honest use of this number is as a planning check. Work out your sustainable rate, compare it against the growth you are actually planning, and if the plan is faster, decide in advance where the funding is coming from rather than discovering the gap in a cash flow forecast eighteen months from now.

The four levers, and what each one costs

Sustainable growth is return on equity times retention, and return on equity breaks down further into margin, asset turnover and leverage. So there are four things that move it. Here is each one applied on its own to our 10.50 percent baseline:

Retain more. The fastest lever and the bluntest. Cutting the dividend to zero takes this company from 10.50 to 15.00 percent immediately. The cost is obvious and falls on shareholders, and for a listed company a dividend cut carries a signalling penalty well beyond the cash involved.

Improve margin. More profit on the same sales raises return on equity and therefore growth. It is the healthiest lever and the hardest, which is the usual arrangement.

Improve asset turnover. Generate the same sales from a smaller balance sheet, and the equity supporting it stretches further. Usually this means working capital: less stock, faster collection. Our asset turnover calculator measures where you are.

Use more leverage. More debt per unit of equity means each retained pound supports more assets. This raises the sustainable growth rate arithmetically and raises risk at the same time, and unlike the other three it has a hard ceiling: lenders stop, and interest coverage tells you roughly where.

Worth noticing that the first and fourth levers change nothing about the business. They change how it is financed. The middle two make it genuinely better. A company whose sustainable growth is rising because of margin and turnover is in a different position from one whose sustainable growth is rising because it stopped paying dividends and borrowed more, even though the number moves the same way.

Which equity figure, and why it changes the answer

The textbook definition uses beginning equity, meaning the balance the company started the year with, because that is the capital base that actually generated the year's profit.

Most people reach for the balance sheet in front of them, which shows closing equity, and closing equity already contains this year's retained profit. So the denominator is bigger and the answer comes out lower.

On our example, where the company began with 1,000,000 and retained 105,000:

A full percentage point of difference on the same company and the same year, from a choice nobody usually mentions.

Neither is wrong. Beginning equity is more theoretically correct and is what most textbooks and most published sustainable growth figures use. Closing equity is more conservative and easier to find. The rule, as with every ratio in this family, is to pick one, know which one you picked, and never change it partway through a comparison.

If you want the textbook figure from this calculator, enter last year's closing equity rather than this year's.

Reading the number honestly

The sustainable growth rate is a model, and it holds several things still that do not stay still in practice.

It assumes margins persist as the business grows. Often they improve with scale, sometimes they deteriorate as a company reaches beyond its best customers.

It assumes asset turnover is constant, meaning that each additional pound of sales needs the same assets as the last one. Businesses with spare capacity can grow substantially with almost no new assets until that capacity runs out, at which point they need a large step of investment all at once. The model sees a smooth line where reality has a staircase.

It assumes leverage stays put, which is a policy choice rather than a fact.

And it says nothing about whether the growth is available. A company can be perfectly capable of funding 10 percent growth in a market that is shrinking.

None of which makes it less useful. It makes it a starting point rather than a target. The right way to use it is as the question it implicitly asks: if you intend to grow faster than this, what specifically are you going to change, and have you arranged it yet?

Two habits worth having. Calculate it for several years, since one year's profit can be unrepresentative. And calculate it alongside your actual growth, because the gap between the two, in either direction, is usually the most informative thing on the page.

Questions people ask

How do I calculate the sustainable growth rate?

Multiply return on equity by the retention ratio. A 15 percent ROE with 70 percent of profit retained gives 10.5 percent.

What is the retention ratio?

The share of profit kept in the business rather than paid out. One minus dividends divided by net income. Paying out 45,000 of 150,000 gives a retention ratio of 70 percent.

What happens if I grow faster than my sustainable rate?

You need external funding every year, and the requirement grows with you. New debt, new equity, or a change in margin, turnover, retention or leverage. See the section above.

And if I grow slower?

Cash accumulates. That is comfortable, but capital sitting idle drags return on equity down, which is why companies in that position start paying larger dividends or buying back shares.

Should I use opening or closing equity?

Textbooks use opening. Closing is easier to find and gives a lower, more conservative figure. On our example the two differ by a full percentage point.

My company pays no dividends. What is my rate?

Then retention is 100 percent and your sustainable growth rate equals your return on equity exactly.

Can it be negative?

Yes, if dividends exceed profit. The retention ratio goes negative, and the figure is telling you the equity base is shrinking rather than supporting any growth.

Where do share buybacks fit?

They are economically a distribution, so including them alongside dividends gives a more honest retention ratio. Many published figures leave them out, which overstates sustainable growth for companies that buy back heavily.

References

A note on sourcing. The sustainable growth rate as return on equity multiplied by the retention ratio is a standard corporate finance result, generally attributed to Robert Higgins, and the underlying decomposition of return on equity into margin, asset turnover and leverage is the DuPont framework. Industry data on returns and margins, useful for judging whether the components are realistic, is compiled by Aswath Damodaran at NYU Stern and updated each January.

1. Higgins, R. C., How Much Growth Can a Firm Afford?, Financial Management, Vol. 6, No. 3, Autumn 1977, pp. 7 to 16.
2. Damodaran, A., Return on Capital by Sector, United States, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/roc.html
3. Damodaran, A., Margins and ROIC by Sector, United States, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/mgnroc.html
4. Damodaran, A., Useful Data Sets, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html