Sustainability

Sustainable growth rate (SGR) = Return on equity x (1-dividend –payout ratio)

2015 > 48% x (1 – 0.621) = 18.19

2014 > 48 % x (1- 0.568) = 20.74

2013 > 36 % x (1- 0.563) = 15.73

Sustainable Growth rate refers to the highest growth rate that can be sustained by a company with having to raise its financial leverage or seek outside outsourcing.  For the 2015, 2014, 2013 the Dunkin' Brands firm could grow safely at 18.19, 20.17 and 15.73 percent respectively using own funds and having no need of outside finances and still manage to continue sustaining itself.  The actual growth rates for the firm over the three years included 46.24, 21.32 and -34.55 percent for 2013, 2014 an 2015 respectively in terms of revenue. The actual growth rates shows a very big difference with the sustainable growth rates which means that the firm had to obtain outside sources of financing in order to attain such high rates for the years 2013 and 2014.  The higher actual growth rates means that the firm did not have adequate cash in hand for meeting the needs at the rate at which it was growing. As the firms’ sales increased, there were required additional funds which could finance the various operational costs such as labor.

If firms grow at an actual growth rate that is inconsistent with the sustainable growth rates, such that sales expand at a rate which exceeds the sustainable rate, some fundamental business rations have to change. If a firm’s actual rate of growth is more than the sustainable rate for a short period, the needed funds may be borrowed.  If this happens for longer periods firms will have to formulate financial strategies. An actual growth rate that exceeds sustainable growth rate can be a sign of difficult times ahead (Palepu, 2007). It can be the case that the higher growth may not be sustainable in future and therefore, there can be a considerable reduction in growth ahead since the firm is having its financial resources depleted.  While an actual growth rate is not a negative by default, it means that a company will have to funds its increasing operations through other sources of money such as new debts, reduction in dividends issuance of new stocks or even an increase in profit margins (Palepu, 2007). Many of the new companies prefer not to take on debts or issue additional equity at the beginning and may result to slowing the firm’s growth to a rate which can be sustained. However, an actual growth rate than the sustainable rate of growth can serve as a proof that a firm is not performing to its maximum.

If the rate of actual growth is higher than the sustainable growth rate, the firm may have to finance its additional operations through borrowing; this means increasing its financial leverage permanently inform of more debt uptake .the firm can also consider selling more equity to raise the funds or reduce the amounts of dividends so as to have adequate finances for these operations. In addition, a company may consider raising its profit margin or reducing its total assets to sales percentage. In practice , firms are most of the times reluctant to carry out these measures and do not like the issuance of equity as an option of financing due to the high cost of issuing and the possibility that earnings per share may be diluted(Klein & Iammartino, 2010). Moreover, the nature of equity as a source of fund is unreliable on terms that can favor the issuer (Klein & Iammartino, 2010). A company can only raise financial leverage if it has assets which can be pledged and if it has a reasonable debt-to-equity ratio as compared to its industry. If the firms decide to reduce dividends, there can be negative effects on the stock price of the firm. Firms may try a liquidation of marginal operations, price increment or embark on enhancing its distribution and manufacturing efficiencies to attain profit margin improvement. Additionally, companies can decide to uptake more activities through outsourcing or through rent production equipments and facilities whose overall effect is to improve the ratio for asset turnover. However, it can be difficult to raise the profit margin which may make it impossible to attain large sustainable increments. Hence, a company may grow to quickly which in turn can lead to reduction in liquidity and unnecessary financial resources depletion (Klein & Iammartino, 2010).

If the rate of actual growth is less than the sustainable rate, it means that a firm is not performing to its fullest. The case of sustainable rate of growth being less than actual rates of growth happens to the mature firms. In such a scenario, the main objective of management is to find the productive use of the excess cash flow. This also means that a firm is underperforming. The firm may have h option of rewarding stockholders due to poor performance by returning the funds the shareholders though the repurchase of common stock or increasing amount of dividends (Palepu, 2007).

References

Klein, P. J., & Iammartino, B. R. (2010). Getting started in security analysis. Hoboken, N.J: Wiley.

Palepu, K. G. (2007). Business analysis and valuation: IFRS edition, text and cases. London: Thomson Learning.