How to Calculate Your Sustainable Growth Rate

Remove emotion and focus on facts during expansion decisions. ( Top Producer )

Remove emotion and focus on facts during expansion decisions

Business growth of any kind offers risk and rewards. Perhaps you’d like to expand your team and bring a child back to the farm. Or, you could pick up another 200 acres this year. Or, someone approaches you about a collaborative farming partnership. These opportunities are often overrun by emotions and can require fast decisions. 

“Farmers have historically felt like we need to grow, but most have a reactive — not proactive — strategy for growth,” says Dick Wittman, a family business consultant and Idaho farmer. “This causes lost opportunities and serious consequences to the business. Far too many growth discussions are not focused on a thoughtful and planned strategic plan for growth, nor do they have a defined metric for determining the optimal rate of growth.”

To evaluate if your operation should expand, calculate your sustainable growth rate. Put simply, this metric shows the maximum rate of growth a farm can maintain without increasing financial leverage or obtain outside financing.

“Financial leverage will allow you to grow faster, but it also increases your risk,” explains Michael Langemeier, Purdue University ag economist. “Your sustainable growth rate lets you figure out how fast you can grow if you didn’t borrow money.”

Track Equity Changes

“One of the most important exercises farmers can do is to determine why their equity is changing, Langemeier says. The two sources of changes in equity include:

  • Retained earnings 
  • Growth in land values

“Once you have the appreciation of land values separated out and know its contribution to growth in equity, you can focus on retained earnings,” he says. “Your retained earnings are what increase your sustainable growth rate.”

Many financial metrics are historical, but this growth metric is important for the future, Langemeier says. By tracking it annually, you can project real numbers for decisions around increasing your team’s head count or adding a new venture. 

Involve your lender in calculating and monitoring this metric. They can help you use this metric or a similar formula for understanding the ramifications of business growth. 


How to Calculate Your Sustainable Growth Rate

(Net Farm Income – Owner Withdrawals) / Net Worth = SGR

 

To find a list of the 10 questions to ask before growing your farm, visit AgWeb.com/growth-questions


Read more from Top Producer

Comments