 financial policy and growth go side by side and a firm needs to keep a balance between these two variables very carefully. We know that there is a direct link between external financing and growth. Growth rates are very useful in financial planning in terms of long-range and in short-range even. There are two growth rates. One is internal growth rate. External growth rate is such a growth rate that a firm needs to maintain without any kind of financing. At this rate growth in assets can be financed through internal resources only. The firm does not need any type of external financing either in the form of equity or in the form of debt. At this growth rate even the firm can maintain its debt equity ratio at one. On the screen you can see the internal growth rate model. There are two variables used in this model ROA and B. ROA is return on assets and B is the retention. You can see the computed internal growth rate 9.65%. This growth rate means that a firm can grow in its assets without any kind of external financing every year 9.65%. On this rate the growth of the firm's assets and the growth of the firm's additional retained earnings are equal. The second growth rate is the sustainable growth rate. If a firm wants to grow above the internal growth rate, the firm definitely needs external financing. So sustainable growth rate is a rate that a firm can achieve without equity financing. This means if a firm does not want to increase its equity, the firm may use debt in order to maintain a rate above the internal growth rate. Now the question arises that why a firm does not want to raise equity? Two reasons are that shareholders do not want to dilute their ownership. Number two, shareholders do not want to dilute their earnings per share. So the better option rests with the firm is to raise debt. Sustainable growth rate is equal to return on equity into B over 1 minus ROA into B. Again two variables are there. One is return on equity and the other is B. B means retention or retained earnings, addition to retained earnings. On this screen you can see an income statement and balance sheet is made with a 20% increase. After the 20% increase, the addition in retained earnings is $3.4. And if we collect the retention of this $3.4, the return of $250 in the owner's equity then our owner's equity reaches $3.3. Now there is a shortage of $53.4. To raise this $53.4, the firm has only one option, to raise debt. And if the firm raises this debt, then the total liabilities of the firm and the equity side firm will be equal to the assets of the firm. The second growth rate is a sustainable growth rate. This growth rate tells us that on this rate, the firm can grow to this extent without external equity financing. If a firm wants to grow at a rate more than the internal growth rate, the firm would definitely require to go for the external financing. So for external financing, the firm has two options, either get the firm equity financed or go for debt financing. So the rate that the firm approaches at the highest growth rate without equity financing is called a sustainable growth rate. A firm may not go for the equity financing because of two reasons. Number one, the equity financing might be expensive due to certain issue of expenses or other governmental duties. Are the existing shareholders may not want to dilute their holdings or their earnings? At a sustainable growth rate, the debt-equality ratio remains at 1. On the screen, you can see a projected income statement and a balance sheet grown at 20%. The example has been taken from the previous. Two variables are used for SGR, one ROE and the other B. ROE stands for return on equity and B means retained earnings in addition. This means flowing back or retention. This calculation shows a sustainable growth rate of 21.36%. This means that a firm without going for equity financing can grow annually at the rate of 21.36%. Using this rate, we had additional retained earnings at 53.4 dollars. This means that when we add 53.4 dollars to the owner's equity, which was of 250 dollars, the total comes to 303.4 dollars. Still, the firm needs 53.4 dollars to finance its growth in the assets. If the firm does not want to increase the owner's equity, the firm will increase its total debt by 53.4 dollars. Sustainable growth rate shows a relationship between four major areas a firm needs to concentrate. The first is operating efficiency, which is measured by a profit margin, which may be operating profit ratio, gross profit ratio or EBIT. The second is asset use efficiency, that how efficiently a firm uses its assets and this efficiency is determined by asset turnover ratio. The third variable is dividend policy, that what is the policy of the firm in terms of its dividend payout and that policy can be procced by dividend retention ratio. The last one is the financial policy. This means that how much composition in terms of debt equity ratio the firm wants to maintain. Dear students, all those factors that determine the return on equity are also important determinant of growth. Remember that increasing return on equity will increase sustainable growth rate by making its upper side higher and the lower side at the smaller. So far as the B or retention is concerned, there would be no change. There are four important determinants of growth. The first one is profit margin. Higher is the profit margin, higher is the amount is available in terms of retained earnings for a firm to finance its growth. The second is dividend policy. If a firm decreases its payout, this means the firm now has enough amount of resources to finance its growth in the assets. The third important dividend is financial policy. This means that how firm manages to maintain its debt equity ratio. If a firm increases its debt equity ratio, the firm has enough resources to finance its projected growth. The last one is total assets turnover ratio. This shows the firm efficiency in usage of its assets. Higher is the assets turnover ratio, higher is the resources available with the firm to finance its projected growth.