Don’t Bite Off More Than You Can Chew

Sustainable Growth RateBusiness growth presents special challenges in financial planning because executives often believe growth is something to be maximized. Unfortunately, fast-growing companies that lack the financial acumen to manage their growth can and do fail.

Increased sales require more assets of all types (i.e., inventory, accounts receivable, productive capacity), which must be paid for. Retained profits and new borrowings generate some cash, but only limited amounts.

Knowing your company’s sustainable growth rate can help you avoid biting off more sales than your company can chew. The sustainable growth rate is the product of four ratios:

G = P x T x R x L where

P is profit margin % (net income / sales)
T is asset turnover ratio (sales / total assets)
R is profit retention rate % (net profit – dividends)
L is assets to equity ratio (assets / beginning equity) or leverage

Unless an owner is willing and able to sell equity or borrow money, the sustainable growth rate is a ceiling on the growth achievable without straining resources. As equity grows, a company can borrow more money without altering the capital structure. The sustainable growth rate then is nothing more than its growth rate in equity.

Here’s an example of calculating a sustainable growth rate:

$1,000,000      Last year’s sales
$2,000,000      Total assets
$   400,000      Beginning equity
10%      P
.5      T          ($1,000,000 / $2,000,000)
85%      R
.5      L          ($2,000,000 / $400,000)

Assuming no additional equity infusion, the sustainable growth rate is:

10% x .5 x 85% x 5 = 21.25%

Assets, liabilities and productive capacity will expand proportionally to sustain growth in sales up to $1,212,500.  Any growth greater than 21.25% will begin to strain resources—debt capacity will be reached, lenders will refuse additional credit requests, and cash will be deficient to pay bills.

Count Your Blessings

Calculate your sustainable growth rate and keep an eye on your numbers. You can have too much of a good thing, whether it’s turkey or sales.

How to Create a Sales Growth Plan

How to Create a Sales Growth PlanTo develop a strategic plan for sales growth, start with the basic sales formula. Total sales is how many customers you have multiplied by the number of times they purchase from you and how much they pay.

So for example, 100 customers who average 10 purchases per year with an average value of $1,000 per purchase results in $1,000,000 in sales.

Open a spreadsheet and plug in your specific sales drivers: 1) number of customers, 2) average number of purchases per year, and 3) average purchase amount. When you multiply these together, you should see (approximately) your total sales for last year.

Play “What If?”

Assume your strategy is to increase sales by 10%. How can you make it happen? One way would be to increase any of the three drivers by 10%. For example, increasing the number of customers by 10% would mean:

CustomersxFrequencyxTransaction Value=Total Sales

If you don’t believe you can increase your number of customers, you can focus on either of the other two revenue drivers: have your current customers purchase from you 10% more often or increase the average sale by 10%.

An alternative strategy would be to increase two of the drivers by 5% each. An example would be:

CustomersxFrequencyxTransaction Value=Total Sales

You might be surprised to see that the result is more than a 10% increase in total sales. That’s due to the effect of multiplying, or working on, the drivers together. You can use this multiplication effect to your advantage by always increasing two or three of the drivers at once.

Finalize the Plan

Try out a few scenarios and see what happens to your sales total. Once you’ve decided on the right combination for your business, create separate plans for each driver you plan to increase and track progress monthly.

Small increases in the three revenue drivers lead to large increases in revenue.