Financial Forecasting and Decision Making

Chapter 9MAXIMUM SUSTAINABLE GROWTH

LEARNING OBJECTIVES

The purpose of this chapter is to show the participant how the basic model can be used to obtain the firm's maximum growth rate. If a company limits its use of debt and has constraints on equity, then sales growth is limited by these factors. After completing this chapter, you should be able to do the following:

•     Identify the concept of sustainable growth.

•     Recall ways to positively influence sustainable growth.

The Basic Model: Maximum Sustainable Growth

Most companies place some limit on the amount of debt they are willing to assume. In addition, raising new equity capital is difficult and may be virtually impossible for most small businesses. Thus, as long as a target debt-to-asset ratio is not to be exceeded, growth is limited.

In order to determine the maximum growth potential for a given time period, one must first begin with a determination of the amount of equity that can be raised internally. This amount depends upon the new sales level (which, of course, depends on the amount of internally generated equity). This joint dependence between the new sales level and new equity can only be solved with simultaneous equations. The algebra is shown on the next page (for those who are interested), but the important matter is the solution.

The Sustainable Growth Model

We know the following from chapter ...