24 Apr Business Alchemy 101 Lesson 14–Affordable Growth Rate (Application)
Affordable Growth Rate by itself does not really give us enough of a story for us to know if the resulting ratio is good or bad.
If you are able to track the AGR over several periods, then you can start to make some sense of whether your AGR is good or bad. However, it is only when you compare the AGR to the Sales Growth Ratio that you can really start to make sense of your situation.
The key to understanding if your growth is affordable is to take a look at the rate your sales are growing and compare that growth over time. If your sales are increasing over time, but your AGR is not growing comparably, that means that you are operating less efficiently as you continue. In other words, if your sales growth is ten percent higher this period than the previous period, then your AGR should be 10% higher this period than it was last period.
Less efficient operation means that less dollars are going back into the pockets of the shareholders of the company. Since the whole purpose of investing in a company (even if you are the sole shareholder and owner of the company) is to create a profit and put more money into your pocket than you put out, this is not sustainable growth.
Unfortunately, this is nothing more than a giant, flashing, neon sign telling you there is a problem, it does not point out where you can find the problem. When you can recognize that you are having this problem, then you really need to get into some horizontal analysis and find out where the inefficiencies are popping up inside the company.
Even using the equity to purchase assets to increase efficiency, pay down long-term debt or pay dividends should not affect the ratio over time. This is because you are always using the Equity from the previous period's Balance Sheet to determine the ratio.
Quite the contrary, this ratio will help you to determine if your actions from the previous period have helped to improve or maintain your efficiency and keep pace with your Sales Growth.
Sales growth is necessary to a business and having affordable growth gives you a solid foundation and as you already know...
...Your business THRIVES on a solid FOUNDATION!!!