How Much Growth Can a Firm Afford?

Abstract

* For years growth has been second only to profits in the pantheon of corporate virtues. In recent years, however, there are increasing signs that some managements must finally face the fact that unrestrained growth may be inconsistent with established financial policies. The intent of this paper is to demonstrate that the financial policies and growth objectives established by some companies are mutually incompatible, and to explore the options open to firms for remedying this worsening problem. To test the consistency of a company's growth objectives and its financial policies, a concept called sustainable growth is introduced. For those companies that want to maintain a target payout ratio and capital structure without issuing new equity, sustainable growth is defined as the annual percentage of increase in sales that is consistent with the firm's established financial policies. If sales expand at any greater rate, something in the company's constellation of financial objectives will have to give usually to the detriment of financial soundness. Conversely, if sales grow at less than this rate, the firm will be able to increase its dividends, reduce its leverage or build up liquid assets. A note of urgency is added to this discussion because, as will be demonstrated, the effect of inflation generally reduces real sustainable growth. If, for example, a company's sustainable growth rate in the absence of inflation is 8%, its real sustainable growth rate measured as the annual percentage increase in physical volume in the presence of a 10% inflation rate might fall to 3.5%. Inflationary growth therefore consumes limited financial resources almost as