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It was Higgins (1977) who brought the concept of sustainable growth, which was discussed
at the global level amid climate or energy crises, to the firm level. The SGR represents the rate at
which a company can grow without running into cash flow problems.
Specifically, Higgins (1977; 1981) developed SGRs for four accounting ratios: dividend
payout, profit margin, asset turnover, and capital structure in equation (1). Higgins' SGR formula is
given by:
SGR = (
RI
NPAT
) ∗ (
NPBT
TO
) ∗ (
TO
NA
) ∗ (
NA
E
)
Where, RI: Retained Income, NPAT: Net Profit After Taxes, NPBT: Net Profit Before
Taxes, TO: Total Sales or Turnover, NA: Net Assets, E: Equity.
If we finally summarize the above equation, Higgins’ SGR is as follows:
SGR = b ∗ ROE
= (1 - dividend payout rate) *
ROE
(1)
The formula (1) represents the sustainable growth rate a company can achieve without external
financing. ROE is the Return on Equity, which is net income divided by shareholder's equity. b is the
retention ratio, or earnings reinvestment rate, or (1 - dividend payout rate) which is the proportion of
earnings kept back in the business as retained earnings.
The sustainable growth in the equation (1), can be determined by its profit retention ratio and
return on equity.The higher the b value, the more profits the company uses for reinvestment, and
sustainable growth is achieved.
Van Horne (1987; 1998; 2007) also derived the concept of SGR. He developed four
accounting ratios, namely: net profit margin, asset turnover, the retention rate of return, and debt ratio.
SGR = Net Profit Margin ∗ Asset Turnover ∗ (1 − Dividend Payout Ratio)
1 − (
Total Debt
Total Equity
)
Where, Net Profit Margin Net Profit Margin: The higher the net profit margin, the higher the
SGR. Asset Turnover: Asset turnover means that the company is using its assets efficiently to
generate more sales. Dividend Payout Ratio Dividend Payout Ratio: Indicates how much of net profit
is paid out to shareholders as dividends. Subtracting this ratio from 1 gives the ratio the company uses
to reinvest its profits.
By expanding formula (1), SGR can be expressed as formula (2).
SGR=
b∗𝑅𝑂𝐸
1−
(b∗𝑅𝑂𝐸)
(2)
Formula (1) represents the maximum growth rate at which a company can grow using retained
earnings that can be raised internally without external financing. Formula (2) represents the
maximum growth rate at which a company can grow, considering its retained earnings and its ability
to grow through external financing (debt).
