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Sustainable growth rate: how fast can a company grow without new equity?

Calculate the sustainable and internal growth rates of a company from its profit, equity, assets and dividends.

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Results

Sustainable growth rate

11.2%

Maximum growth with a constant debt-to-equity ratio and no new shares

Internal growth rate (no new debt or equity)

5.9%

Return on equity (ROE)
16.0%
Return on assets (ROA)
8.0%
Retention ratio
70.0%
Payout ratio
30.0%

How fast can profits fund growth?

Growing a business takes money. More sales usually need more inventory, more receivables and more equipment, all of which have to be financed. A company that does not want to issue new shares has two sources: profits it keeps instead of paying out, and new borrowing. The sustainable growth rate (SGR), popularized by Robert Higgins in 1977, tells you how fast sales can grow if the company keeps its debt-to-equity ratio and its operating ratios constant:

SGR = ROE × b

  • ROE is return on equity: net income ÷ shareholders’ equity at the start of the year.
  • b is the retention ratio: the share of net income not paid out as dividends.

The internal growth rate

A stricter limit assumes the company takes on no new debt at all and finances growth only with retained earnings:

IGR = ROA × b ÷ (1 − ROA × b)

where ROA is net income ÷ total assets.

Worked example

A company earns $2 million net income, pays $600,000 in dividends, and started the year with $12.5 million of equity and $25 million of assets.

  • ROE = 2 ÷ 12.5 = 16%
  • ROA = 2 ÷ 25 = 8%
  • Payout ratio = 30%, so retention b = 70%
  • SGR = 16% × 0.70 = 11.2%
  • IGR = 0.056 ÷ (1 − 0.056) = 5.9%

The company can grow sales about 11% a year by borrowing in proportion to its retained earnings, and about 6% with no new borrowing.

What to do with the result

If planned growth is above the SGR, something has to give. Management can:

  • Raise margins or turn assets faster, which lifts ROE.
  • Cut the dividend, raising the retention ratio.
  • Borrow more, accepting a higher debt-to-equity ratio.
  • Issue new shares, diluting existing owners.

If growth is well below the SGR, the company generates more cash than it can use, and returning it to shareholders through dividends or buybacks may make sense.

Limits

The model assumes constant margins, asset turnover and leverage, which rarely hold for long. Companies with losses have no sustainable growth from earnings. And sales growth that requires heavy upfront investment, such as a new factory, will not follow a smooth annual rate.

This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.

Frequently asked questions

What is the sustainable growth rate?

The fastest a company can grow its sales without issuing new shares and without changing its debt-to-equity ratio. It equals return on equity times the retention ratio, the share of profit kept in the business.

What is the internal growth rate?

The fastest a company can grow using only retained earnings, with no new debt at all: ROA × b ÷ (1 − ROA × b). It is always lower than the sustainable growth rate when the company uses debt.

What if a company grows faster than its SGR?

It must borrow more, issue shares, cut dividends or improve its margins and asset turnover. Fast-growing profitable companies often run short of cash for this reason.

Should I use start or end of year equity?

The simple formula ROE × b is exact when ROE uses equity at the start of the year, which is what the calculator asks for. With end-of-year equity, use ROE × b ÷ (1 − ROE × b) instead.

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Results are estimates provided for information purposes. They do not replace professional advice.

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