Growth Strategy Planning

Planning for Sustainable Growth

Sustainable growth is one of the most important measures of business success and is listed among 37 variables that determine success like market share, market growth, marketing expense to sales ratio or a strong market position. Sustainable growth does not just happen, it must be planned. Technically, a sustainable growth rate (SGR) is the maximum rate of growth that a business can sustain without increasing financial leverage. In other words, SGR measures how fast a firm will grow without external financing. After a firm has passed this rate, its growth will decline in the long term, and it has borrow to facilitate additional growth. SGR is the optimal rate of growth from a financial perspective given a specific financial strategy defined by the businesses financial policy.

Sustainable growth is defined as the annual percentage of increase in sales that is consistent with a defined financial policy like debt-to-equity ratio, dividend payout ratio, profit margin, assets to net sales. The SGR framework provides a comprehensive financial framework and formula for entity specific SGR calculations. The sustainable growth rate model has important implications for business valuation models like the Gordon model and other discounted cash flow models (DDM) require a growth estimate that can be sustained for many years. The sustainable growth rate can be a check if business plans are reasonable.

Implementing a strategy to increase SGR is very complicated since its the product of the businesses return on equity and the percentage of its profits that is invested back into the firm. A simple SGR calculation is: ROE x (1 – dividend-payout ratio) The SGR formula assumes that a company will maintain a target capital structure of debt and equity,(D/E Ratio) keep a consistent dividend payout ratio and accelerate sales as quickly as the organization allows.

Strategic planning is critical to the develop of organization specific Sustainable Growth Model. All businesses desire achieving a good SGR but may lack the internal resources to develop SGR Model or desire an independent objective evaluation. Externally, many factors can prevent a business from growing and achieving an optimal SGR. Consumer trends, the legal environment, global competition, politics, demand and supply, market shifts, new technologies and other factors can help or limit a business’s ability to achieve sustainable growth.

Internally, businesses may make the wrong decision about which projects to invest in, or what operations to increase or eliminate when analyzing profitability. Market Planning is one aspect of strategic decision making that is essential for developing SGR. For example, businesses may be tempted to compete for business by slashing prices and potentially decreasing growth. Companies may also invest money into new product development (R&D) to try to keep existing customers, which can cut into a company’s ability to grow and achieve its optimal SGR. All of the these are strategic decision that require competent analysis and decision making.

Another factor that limits a company’s ability to achieve sustainable growth is its strategic planning capability which is impacted in part by its managerial accounting practices. Many companies confuse growth strategy with growth capability and misidentify the optimal SGR. If this happens, a company will achieve high growth in the short term but it will be unsustainable. Also, when growth exceeds the optimal SGR, growth is greater than what the company can self-fund, and it is important to develop a finance strategy that will increase equity, financial leverage, reduce dividend payouts, increase profit margins, or decrease the asset to sales ratio, or a a combination of these. Any of these factors can increase the SGR to a higher level.