OVERVIEW

Growth is important to financial health. But it is possible growth may be too rapid for a firm's own good, particularly if operations are small or if financial planning is deficient. The problem is that the more accelerated the growth rate, the greater the requirement for funds to support growth particularly if growth is exponential and the borrower is saddled with high operating leverage. The resulting high debt ratios could easily cause financial problems, leaving the firm open to the flight of suppliers and customers. The sustainable growth model helps stave off excessive leverage problems by bringing to equilibrium the borrower's capital structure and targeted sales.

The sustainable growth rate is the maximum rate that sales can increase (over the foreseeable future) without depleting financial resources. In simple terms, operating units need money to make money. Sustainable growth solutions center on boosting equity when volume accelerates, thus maintaining the "right" balance between liabilities and equity. Industry benchmarks act as points of reference and reflect the cumulative decisions of management, lenders, suppliers, customers, and competitors. Whenever the relationship between liabilities and net worth is significantly below industry standards, questions arise about management competence and the firm's unsystematic risk control. Just look at the spreads between treasuries and the rates charged on corporate junk bond issues sitting in the lowest quartile of their respective industries.

The special case cash flow model we call sustainable growth measures the probability that sales increases within highly leveraged, rapid-growth companies stress out the financial structure.