The Comparative Analysis of Sustainable Growth Pattern

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The Comparative Analysis of Sustainable Growth Pattern
YANG Guoli, YANG Shujun
Accounting Institute, Hebei University of Economics and Business, P.R. China, 050091
lee7301 @126.com
Abstract: This paper introduces the definition of sustainable growth of corporation. since we aware that
the sustainable growth is important to the enterprise, we have the necessity to compare the four existing
sustainable growth models, and reveal the advantages and limitations of the four existing sustainable
growth models in logic and practice respectively. we use the seven-year data of the listed
comporation-wanke to verificate the four existing sustainable growth model, in order to provide some
reference to enterprises when enterprises calculate and practice their sustainable growth rate. At last, this
paper puts forward some advice by examining the present situation and the unsettled problems of
sustainable growth of the corporation in China.
Keywords: Sustainable growth, Comparative analysis, Case
1 Introduction
Professor Higgins wrote an article "under the financial sustainable growth rate of inflation", in which he
put forward the equation of finance sustainable growth rate, in the Financial Management Science which
was published in 1981. he expressed systematically the view of the financial sustainable growth rate. He
said: "the enterprise's financial sustainable growth rate(SGR) refers to the biggest increasing sales by
enterprises under conditions of financial resources are not exhausted ". It is a comprehensive enterprise
financial indicator, it embodies enterprise ability to grow in the existing management level and financial
policy conditions, and we should take it as the enterprise financial analysis and management tools. In
order to facilitate the further research enterprise growth management problems, professor Higgins
deduced the enterprise's financial sustainable growth equation based on the definition of sustainable
growth of financial basis. The formula of the sustainable growth that professor Henry Higgins deduces
and the basic principle and assumptions of static model of James Van Horne are the same.
This article comparatively analyses four sustainable growth models, while a different application cases
demonstrate sustainable growth model, which concluded that: based on the sustainable growth of free
cash flow model of value and growth of the contact, the growth of the enterprise management more
references.
2 Comparative Analysis of Sustainable Growth Model
This article lists two categories of sustainable growth models.
2.1 The model of sustainable growth based on accounting
The most classical models have two, one is made by Robert C Higgins, the other is put forward by Keith
Van Horn. The theoretical starting point and the logic of the two classical models are essential the same,
they start from the accounting equity, and owners’ equity growth of enterprises limits the growth of
enterprises. The two models base on a series of similar assumptions, such as the stability of rates and
availability, stablility of financial policies and operation performance.
2.2 The sustainable growth rate based on cash flow
The sustainable growth rate based on cash flow concern the relationship between the growth and cash
flow. We Introduces Rappaport sustainable growth model and kore sustainable growth model here.
Rappaport think that sustainable growth should be consistent with the value creation. He believes that
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sustainable growth should lead to the continuous sustainable increase of shareholders’ value. So he puts
forward the bearable growth, which recognizes operating profit margin, the dollar amount of investment
growth in corresponding with every dollar of sales growth, target asset-liability ratio and target dividend
distribution rate. The bearable growth is the biggest annual growth, named the sustainable growth of the
enterprise. We are agree with the sustainable growth that defined as affordable growth by Rappaport in
this paper.
Kore describes the relationship between the cash flow and the growth rates. Based on a series of
assumptions through calculating cash flows and growth rates, he defines that the sustainable growth is
the growth rate when cash flow is equal to zero. He pointed out that the cash flow and the growth rate is
a negative linear correlation.
The two sustainable growth models that based on cash flow is essencial the same. That the sustainable
growth rate is the growth rate when cash flow is zero in the two models both of them based on the cash
flow is consistent. The cash flow should be limited to the specialized cash flow, named the free cash
flow. The two models of growth establish a direct link with the cash surplus and cash deficiency, state
business the negative correlation relationship between the growth and cash flow, describe the most
important factor in business growth--- the free cash flow of the enterprise.
3 Case Verification
In order to verify the rationality and differences of the two categories of sustainable growth models, we
selecte relevant data from 2004 to 2010 of B corporation---a listed corporation in China in the paper. We
use the data to verify the two categories of sustainable growth models. We know the distinguish
difference between the two categories of sustainable growth models from the above, are virtually
identical in each category among the sustainable growth models: the steady state in Higgins model and
Van Horn model can be intertransformed, so are Rappaport model and the kore model. Therefore, in
order to concisely explain the difference between the sustainable growth model based on accounting and
the sustainable growth model based on cash flow, we choose only the Higgins model and Rappaport
model to compare data in the paper.
3.1 General Financial Analysis
In 2010 Annual financial report, our sample--B corporation describes the summary of the corporation’s
past and future as the following: "we(listed corporation B) are eager to grow in high speed as well as
fellow corporations, but we never must gamble on the interest of corporation shareholders to win a such
short glorious moment. Listed corporation B believes that the competitiveness of enterprises is not
short-term but long-term, the sustainable growth rate is the fundamental of the long-term victory.”
Listed corporation B knows that rapid growth is risk for a business, and attempts to decerase the growth,
but the growth does not decrease.
2004
Table 1
Main operation
revenue
2268690804.98
Financial basic data of corporation B
Cash flow generated
Net profit
from operations
202092922.01
-140274510.21
Cash flow generated
from investment
-16008717.13
RMB¥
Asset-liability
ratio%
48.2900%
2005
2872795889.97
214221400.03
42785872.95
52433186.14
52.2400%
2006
3783668673.99
296647130.02
86048364.96
36461979.89
47.2600%
2007
4455064775.01
373747218.12
-1204549248.03
-228206969.28
51.7900%
2008
4574359628.96
382421273.98
128843265.12
33695293.99
58.2800%
2009
6380060445.19
542270657.99
-1478383769.94
7165072.90
54.9100%
2010
7659226229.92
878006254.97
1048590342.02
458870210.10
59.4300%
Year
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It can be seen from Table 1, corporation B is undoubtedly attach great importance to the growth of
corporation, and it seems that corporation B pursues growth each year. Its main business income does
achieve annual growth. The main business income rises almost four times from 2004 to 2010, and the
corporation seems having a good future. However, in contrast, cash flow generated from operations of the
corporation B does not keep up with the pace of main business income. Corporation B’s cash flow
generated from operating activities reveals the surface of prosperity, and Corporation B is faltering in fact.
Net cash flow generated from operations of corporation B from 2004 to 2010 is fluctuation around the
zero line scale. In particular, from 2006 to 2009, rapid growth in business revenue and decline of the
operating net cash flow form a "bell", which shows that revenue growth does not bring cash flow into
the enterprise but decrease the original cash flow.
If corporation B is evaluated by a measure of revenue growth, corporation B is undoubtedly the leader in
the industry. However, the growth of listed corporation B does not bring value to the listed corporation
B itself. If the listed corporation B is evaluated by Rappaport's valuation model, only the free cash flowmodel of the molecular is considered, we can see that corporation B is not as excellent as we think. In
fact, corporation B is worth of little value. Listed corporation B does not achieve that it is ready for a
"marathon".
3.2 Analysis of Sustainable Growth
According to the data of listed corporation B from 2004 to 2010, as well as the formulas of Higgins
model and Rappaport model, we can calculate and get data in Table 2.
Table 2 The computational results
Date
Main operation
revenue growth rate
Higgins's sustainable
growth rate
Rappaport's sustainable
growth rate
December 2004
16.47%
9.02%
-494.07%
December 2005
26.52%
5.30%
-90.91%
December 2006
32.70%
36.98%
52.88%
December 2007
18.73%
9.01%
-229.99%
December 2008
2.67%
11.97%
58.04%
December 2009
40.46%
33.97%
-509.04%
December 2010
19.16%
32.01%
50.91%
According to Rappaport's model in 2004, net profit rate of listed corporation B is 8.72%; liabilities and
equity ratio is 93.42%; dividend distribution rate is 24.54%; the molecule of the model is 12.73%. The
whole year's capital expenditure is 230,308,965.11; working capital increases; the two is 10.15% of
the main business income; the denominator of the model is only -2.58%; there are net cash inflows close
to zero, which leads to abnormally low sustainable growth calculated through this model.
We should note that the amount of investment is met by the net cash flow generated by sales in 2004;
the demand of investment is very low; the corporation exist idle cash. If the enterprise does not have a
good investment, the funds should be returned to shareholders, which can maximize the corporation
value, according to Jensen's theory of free cash flow. In order to verify this, the rate on retained earnings
is equal to the year's investment needs; it is found that a positive sustainable growth rate rises to 20.3%.
This shows that dividends distribution creates value for shareholders, which proves the rightness of
Jensen's theory. The abnormality of sustainable growth in 2007 and 2009 by Rappaport model is the
same reason as the above.
We can see the difference between the two types of sustainable growth model more clearly from Figure
￥
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1. Higgins Gx sustainable growth rate and Rappaport GL sustainable growth rate have huge difference;
Higgins Gx sustainable growth rate and Rappaport GL sustainable growth rate also have large difference
with the main operation revenue growth rate. There is a huge gap between Rappaport GL sustainable
growth rate and the main operation revenue growth rate. Principal reason of the difference is that
Rappaport sustainable growth rate regards net increase of capital expenditure and working capital as a
part of sustainable growth; the innovations of Rappaport sustainable growth model are based on cash
and regardless of capital expenditure itself.
100.00%
0.00%
-100.00%
Rate
2004
2005
2006
2007
2008
2009
2010
-200.00%
-300.00%
-400.00%
-500.00%
-600.00%
year
Main revenue growth
Figure 1
Higgins, Gx
Rappaport, Gl
Comparison chart of sustainable growth
We can see the followings from comparison of several curves in Figure 1:
3.2.1 GL fluctuates rather greater than Gx. This shows that the cash flow of the listed corporation B is
not a strategic plan, which results from net cash flow generated from operations and net cash flow
generated from investments unstable from 2004 to 2010. The instability of cash flow generated from
investment also shows that the investment strategy of listed corporation B is not clear. Listed
corporation B discloses yearly competitive strategy in their annual financial reports every year, but data
of listed corporation B shows that the competitive strategy is implemented differently from its designed
aim; the bad-arrangement of cash flow is the most important thing, which is actually a significant
financial risk. If the competitive is specific, is implemented effectively and can accurately be consistent
with the cash flow, the GL should be smooth.
3.2.2 We can see the relationship between the curves: if the main opertion revenue rate grows faster
than the Gx in th year, GL is negative; if the main opertion revenue rate grows slower than Gx in th year,
GL values is positive. The main opertion revenue rate grows faster than Gx; GL values are negative in
2004, 2005, 2007 and 2009. The main opertion revenue rate growth is lower than Gx, GL is positive in
2006, 2008 and 20010. According to Higgins theory, when growth rate is higher than the sustainable
growth rate, the corporation is short of cash; when the growth rate is lower than sustainable growth rate,
the existing cash exceeds the cash demanded. Our case is a clear evidence of Higgins theory. That the
main opertion revenue growth rate is higher than Gx, the GL appears negative in 2004, 2005, 2007 and
2009, indicates that growth at this time can not actually increase shareholders’ value, can not increase
more cash flow. the growth rate is actually destroyed shareholders’ value. That the main opertion
revenue growth rate is lower than Gx, GL is positive in 2006, 2008 and 20010, indicates that moderate
growth in corporate can increase cash flow, and benefit value creation of the corporation.
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3.2.3 Difference between point and point. The main difference between point and point is that we
consider capital expenditures in GL. As we can see from the data, Rappaport's sustainable growth model
is a modest investment concept. Excessive investment and insufficient investment can not make the GL
positive. Because the denominator is negative, GL is negative. This indicates a large number of cash
deposit in the corporation and insufficient investment. The corporation has not only no capital
expenditure, but also receives cash inflows from investing activities in 2001. Because waste of funds
hinders the growth, growth is negative. That the modest or normal investment increases value shows the
GL positive. We can see that capital expenditure is 26.67%, 36.6%, 50.95% of the main opertion
revenue respectively in 2006, 2008 and 2010; the GL is more than 50% in 2006, 2008 and 2010.
4 Conclusion
We find that the volatility of sustainable growth rate calculated by the sustainable growth model based
on cash flow is more intense; the corresponding relationship between corporate cash flow and the
sustainable growth rate is more explicit; the modest or normal investment is appropriate to prepare for
future growth.
Rappaport's sustainable growth model actually links growth with value creation through the cash flow
by means of sustainable growth. According to Rappaport's sustainable growth theory, if the sustainable
growth rate is negative, shareholders’ value is damaged; if sustainable growth rate is positive, the
enterprise value is increased. Value creation is the result of the implementation of corporate mature
strategies; sustainable growth shows the implementation of enterprise mature strategies. The corporate
grows stablely and longly, value is created sustainable depend on mature strategies, taking into
account the long-term interests and short-term interests, stable profitability model, capital structure and
dividend distribution policy, stable long-term
Cash flow, as the "blood" of enterprise survival and development, plays an important role in the
management of enterprise undoubtedly, whether people explain the enterprise value using cash flow
differently. The enterprise must ensure that cash--an important part of the enterprise value chain flows
continuously which is the basic rule of business survivaland the basic function of corporate finance. The
significance of sustainable growth is that sustainable growth can avoid blind expansion, cash outflow
exeeding cash inflow, which may lead to bankruptcy of growth. Based on the above, we believes, for the
management of growth, for sustainable growth, that it is more realistic and meaningful based on cash
flow than based on accounting standards.
Acknowledgment:
This paper is supported by a grant No1457201D-42 from the Science and tecolology project of Hebei
Province.
References
[1]. Higgins, Robert C.How Much Growth Can a Firm Afford?Financial Management.Vol.6.(Fall).
1977:7-16.
[2]. Higgins, Robert C.Sustainable Growth under Inflation.Financial Management. Vol. 10. (Autumn).
1981:36-40.
[3]. Van Home, James C.Sustainable Growth Modeling.Journal of Corporate Finance. Vol. 1. (Winter).
1988:19-25.
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