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1.0 Introduction

Financial performance evaluation and assessment can be mediated through the usage
of financial tools or medium, concepts, theories and applications. There are financial
medium that can assist firms in conducting their assessment and evaluation of financial
performance. One of the available tools is using the leverage on sustainable growth rate
(SDR). The uncertainty of economic turbulence due to pandemic has affected the
financial strength of organization especially the dilemma of either raising new funds to
meet financial obligation or stick to their status quo.

The preference of using the sustainable growth rate is important because it explain two
very important perspective in facilitating decision making of a firm. Firstly, it depicts the
current state of organizations’ financial condition that enable analysts and the investors
estimate the rate of growth. Secondly, the SGR rate serve as estimation when it comes
the quantum of raising external capital. The rate of SGR indicates whether the firm
could maximizing sales and revenue growth without increasing financial leverage on
raising debts to maintain its sustainability of operations.

2.0 Problem

The risk of failing to sustain a good SGR might affect the financial position of a company
to maintain its operations thus leading to raising additional debt as leverage. However,
the ability to maintain high rates constantly for a long period of time is relatively difficult
to achieve. This is due to the fact that when revenue increases, sooner or later it will
trigger toward sales diminishing or saturation point after a period of time. In mitigating
the sales downturn, the organization need to explore on producing into products
diversification. Definitely, this process will affect lower profit margins. Therefore, lower
profit margins could cause strain in financial resources and potentially lead to a need for
new financing to sustain growth. On the other hand, failure to secure a good rate will
expose the organization at risk of stagnation.

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The main objectives in evaluating and assessing the SGR calculation are when the
company aspire to maintain a targeted capital structure comprises of debt and equity,
maintain a static dividend payout ratio, and accelerate sales as quickly as possible as
and when the organization can afford it.

In the case, when a company's growth becomes greater or lower, the firm must devise a
financial strategy that raises the capital needed to fund its rapid growth in the case of
higher rate to fund its operations. The company can issue equity, increase financial
leverage through debt. This consequences would definitely reduce dividend payouts
and extra efforts to increase profit margins by maximizing the efficiency of its revenue.
All of these factors can increase the company's SGR.

3.0 Literature Review

3.1 Sustainable Growth Rate: Definition and Preference

There are various definition of sustainable growth from the perspective of finance.
Sustainable growth can be illustrated as growth within the firm’s financial constraints
(Alayemi & Akintoye, 2015). This can be done without having to increase the leverage
of finance (Ross, Westerfield, & Jordan, 2010). However, the main concern is on the
integration of the three main elements in pursuing growth objectives such as economic,
environmental, and social activities and late formulated into organizational strategic
goals (Harmon et al., 2009).
However, the integration of all three ingredients could not be afforded by small scale
enterprise. According to Goswani, 2015), small scale enterprise unable to possess the
three elements of sustainable growth at the disposal of their mission and objectives.
Other definition correlates with long term perspective of growth (Stefanikova, Rypakova,
and Moravcikov, 2015) and achieving growth without having financial, structural or
strategic setbacks (Schwab, Gold, Kunz, and Reiner, 2017).

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According to Firer (1995), the maximum growth rate that a company can attained is
considered as SGR while having the other parameters remain constant (ceteris
paribus). Based on the above definitions it can be conferred that Sustainable Growth
Rate is the maximum rate of growth in sales that a firm can sustain without issuing any
additional equity or changing its financial policy. In other words it indicates the maximum
growth rate in sales a firm can achieve using both internal and external sources of
financing without alatering the debt-equity ratio.

Internal and External Financing

The decision in favor of either internal or external is the decision made by the finance
managers choice especially to what extend the mixture of debt and equity to be dealt in.
(Mohamed Zabri et al., 2017). Practically most of the small medium enterprise will rely
on self-raised financing or occasionally derived from close family funds (Houssain et
al., 2006). The preference of small medium enterprise opting for informal sources
according to Berger (1988) can be explained through theoretical senses such as the
signal theory. The other related theories are information asymmetry and the financial
growth paradigm.

On the other side of the coin, when an enterprise seeking to have external financing it is
said that the debt option is preferred more than the equity (Fatoki & Odeyemi, 2010). In
reality, all these theories entails and describes the challenges face by small medium
enterprise. This is because micro-enterprises are not in the positions to issue equity to
the public. In addition, most of the finance managers wouldn’t agree with the proposal
that reduced their intervention and influence in such decision.

Signaling theory exerts that the manipulation of finance manager function through its
dominant decision that influence the choice of financing (Baker et al., 2017). This is a
clear cut observation that any funding decisions deliberately determined by the
characteristics of management. Other characteristics includes amongst other are age
and length of experience. In addition, the competence in having networking as well as

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the ability of managing internal funds also included in the management characteristics.
(Alakaleek & Cooper, 2018). This is clearly indicated that the capabilities and
management behaviour have direct can influence the choice of having external
financing.

The external funding and the sales growth are closely related (Ross et al., 2012). This
can be explained through a hypothesis of the higher growth rate in sales, the huge
amount of external funding to sustain the need for source of funds. Therefore, sales
growth and external financing are directly related to each other considering all other
variables ceteris paribus. There remains no room for hesitation about the fact that a
minimum level of growth is required for the firms to perform well and sustain its growth
in the long run. However, excessive growth is not good for the enhancement in sales
growth (Ross et al., 2012). Excessive growth will endeavor urgencies for external
financing which in turn leads to financial distress as a result of increase in fixed financial
charges.

The survival and the expansion of an enterprise largely rest on sustainable growth rate
and it is considered as a valuable tool to assess the strength and potentiality of the
enterprise. Sustainable Growth Rate is considered as a precious as well as a
comprehensive mechanism in determining the strength of financial capability of the
organization thus portrayed the long run sustainability of a corporation. This is based on
the fact all financial factors are considered including profit margin and asset efficiency.
The second aspect is the financial namely refers to the capital structure and retention
rate parameters. In addition, according to Van Horne (1998) the main considerations of
sustainable growth rate can be attained through few strategic factors namely targeted
maximum operating expenses, debt management and a conservative dividend pay-out
ratios. In a nutshell, it is apparent that with the model of sustainable growth, one can
assess whether the rationale of the company's sales growth is coherent with the
operating characteristics and financial policy reform of the company.

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In another aspects of SGR, Mohamed Zabri et al. (2017) indicated that that highly liquid
firms and rapidly growing firms are less dependable on additional sources due to the
capability of generating enough capital through its retained earnings. This financing
behaviour is consistent with the characteristics of small medium organization which
prefers at any circumstances utilize their internal funding prior to external debt financing.
In this situation, the designated theory applies to the act of internal borrowing rather
than exerting to equity when the internal cash flow is not sufficient to fund capital
expenditures. Thus, the amount of debt will reflect the firm’s cumulative need for
external funds.

3.2 The importance of SGR

The Sustainable Growth Rate (SGR) can be used to gauge and explicitly maneuver the
growth of financially distressed firms. It can also indicates that organization in their
efforts to minimize leverage on external financing. The higher rate of SGR will indicate
whether they will need to raise new funds in order to achieve a level of sales growth
above their SGR.

Interestingly, SGR serves as medium analytical framework to facilitate the decision on

which elements of a firm’s operating and financial structures that management should
prioritized in improving its financial performance. Indirectly, it allow finance analysts to
make yearly performance comparison. Judging from the report, the organization has the
advantage of identifying competitor’s key elements and focus their efforts on studying
the competitors’ strengths and weaknesses.

Kumar and Verma (2018) stressed in their study that SGR can be powerful indicator
that serve as balancing factor in operational and financial strategies. In addition, the
researcher found that it is useful to be applied as an organizations’ strategic planning
process as well acts as control tool (Fonseka, 2012). Moreover, the concept of SGR by
Ashta (2008) is useful for firms that are growing very fast and for those facing financial
distress. This can be done by modifying the calculation it can improve financial analysis

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and clarity by calculating the firms’ SGR. The author’s findings proved that the
modification of the SGR formula was consistent with including the opening assets in the
calculation of asset turnover ratio. Furthermore, the calculation for leverage ratio is
calculated based on the opening total assets be divided by opening equity.

Specifically, the modification of the calculation of the asset turnover rate based on those
changes can be calculated by sales divided by opening total assets rather than dividing
the closing total assets as used by Higgins (1977). The modification to use the same
date is more intuitive because sales are created based on assets rather than other
factors, which are more indirect and remote (Ashta, 2008). Therefore, both assets and
equity should have a specific term in the calculation of leverage ratio; and the value of
the assets should be in the same period.

A widely known framework for the SGR was developed by Higgins (1977), and the
framework identifies four main factors that influence the SGR that includes among other
the organizational capital structure, dividend policy, profitability, and asset efficiency.
The SGR must be tailored with specific measures of a company’s performance. This
measurement can be described by determining the factors that affect a firm’s SGR to
help internal and external stakeholders to arrive at the right decisions.

According to Hartono et al. (2016), the main four factors influencing the rate are:
i. Profitability ratio: Any increase in the ratio index will increase the revenue that
directly impacted the desired growth rate.
ii. Turnover ratio on asset: The generalization is when there is an increase in the
ratio it increases the value of sales generated per asset unit. This in return make
less dependable for additional assets to increase sales.
iii. Finance policy: The SGR will increase when there is an increase in total debts.
As total debt provides additional resources thus increases the SGR
iv. Dividend Allocation Policy: If there is an increase in the retained earning, there
will be an increase in the dividend payout and implicitly the SGR.

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Therefore, the key performance indicator using SGR can be associated with the four
factors mentioned above. The associations of these factors would facilitates the
decision making process for internal and external stakeholders of the organization
especially for the company that faced the impact of COVID-19 pandemic.

In other similar circumstances, the calculation can be applied to financial and non-
financial institutions. In the case of banking, the banks need to attain the annual rate of
return (Vasiliou and Karkazis ,2002). This assessment can be done through an increase
in total assets that can be supported by equity capital generated internally.

On the one hand, by studying annual reports between 2006 and 2014, Mat Nor et al.
(2017) investigated the sustainable growth rate within limited minimum capital structure,
leverage and liquidity requirements of banks in Malaysia, and by using focus group
interviews between 2006 and 2015 to solicit information. In terms of bank growth, both
Islamic banks and conventional bank's Islamic subsidiaries in Malaysia are capable of
sustaining growth through mix-method on growth despite tight risk exposure
requirements.

The SGR helps explain why a proper balance must be maintained between firm growth
and profitability and it is also a useful tool for a banker to determine a company's
creditworthiness (Fonseka, 2012). Therefore, the concept of SGR can be useful not only
for firms but also for banks.

3.3 Mitigating Financial Stress and the Crisis

An extreme higher growth rate may cause financial stress to the organization. This
means the organization will face higher financial costs. The failure of meeting such
financial liabilities might lead to financial losses, deteriorating market share or might
goes to bankruptcy of winding up the company (Fonseka et al., 2012). Financial distress
may arise when a firm has difficulty in paying principal debt and interest obligations

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(Fazzari et al., 1988) and in an extreme case, a firm can become bankrupt. Platt (1995)
also mentioned that many firms in financial distress have limited or no access to the
debt markets. According to Zaki, Bah & Rao (2011), the risk of all key financial indicator
of organization namely the equity to assets ratio, cost to income ration, the rate of asset
growth and non-performing loans (NPL) definitely imposed a positive influence on
financial distress to the organization. Subsequently, many financial agreements
normally require the inclusion of target debt equity ratios in any agreement sealed
(Fazzari et al., 1988).

In addition, the key factors in financial obligation should address the aspect of
organization growth and the organization risk profiling (Kanani et al., 2013). The ability
to sustain and leverage resources effectively will indicate a stronger financial
performance. If this happen, it will elevate good value for shareholder (Gómez-Bezares,
Przychodzen, and Przychodzen, 2017). In other words, the use of debt is limited as
companies might face financial distress or bankruptcy. Also, firms with low growth types
are more likely to issue new debt than equity when the economic and market conditions
improve, while firms with high growth types are less likely to issue debt and equity.
Meanwhile, the relationship between financing and growth behaviour is explicitly
integrated (Molly, Laveren, & Jorissen, 2012).

Anderson and Nyborg (2011) stated that they found a negative correlation between
growth and firm performance. In relation to this, Shaikh (2010) expressed that leveraged
firms can expand their profits in booms. However, in a declining economy, they may
even face bankruptcy. Leveraged firms are more stable and profitable compared to non-
leveraged firms during economic flourish but during recessions, are more risk-prone and
less profitable than non-leveraged firms. As such, leveraged firms rely on good
economic conditions to remain profitable. In addition, leverage amplifies the losses or
gains in business activities (Ilie & Olaru, 2013). Leverage boosts gains and supports
economic growth during good times. As such, governments and firms are using
leverage on a large scale. However, governments and firms deleverage during bad
times. Financial crises can occur due to high leverage and deleveraging will follow a

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financial crisis. This is because firms want to reduce risk and strengthen their financial
stability and sustainable growth rate. In this case, the decision-making process and the
investment guidance are influenced by the company's firm growth and risk of having
better financial performance and shareholder wealth. Shariah-compliant firms
Concerning financial strategies, the Securities Comission (SC) has introduced new
screening methodology benchmarks based on financial ratios (cash over total assets
and debt over total assets) to be listed as Shariah-compliant firms (Securities
Commission Malaysia, 2013). The conventional debt must not exceed 33 percent. Due
to the new screening methodology benchmarks, the number of Shariah-compliant firms
reduced from 801 (May 2013) to 653 (Nov 2013).
One of the reasons for the reduction in the number of Shariah-compliant firms is that
companies have higher conventional debt, where the financial ratios are more than the
limit or threshold of 33 percent (Junaina, 2015). As mentioned earlier, the changes in
financial and operating activities would have an impact on the SGR of a firm. Hence,
financial strategies become one of the important elements for a Shariah-compliant firm
to investigate because the changes in financial activities lead to a change in operating
activities and would have an impact on SGR performance.

4.0 Conclusion

Growth is a good key performance indicator in company‘s operating performance and

their potentiality in regards to how effective they can manage available financial
resources. The fact of having minimum growth is necessary for companies to survive
and perform well in long term but too much excessive growth is hazardous. Adjustment
to sustainable growth, if not corrected, could exert tremendous stress on the company‘s
financial and operating characteristics and may lead to financial distress. Through
Sustainable Growth Rate, financial managers and investors can assess swiftly whether
company‘s strategies for escalating sales are feasible and whether they are based on
company‘s actual operational performance and financial policy. It indicates an increase
in turnover over the value of the sustainable growth rate as computed will create severe
urgencies for additional external financing as a result of shortage of funds, thus lead to

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additional fixed bearing debts and on the other hand, a turnover lower than the rate of
sustainable growth will lead to a misuse or under capitalization of available resources,
thus creating opportunity costs.

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Reference

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Mohamed Zabri . Shafie. Ahmad, Kamilah, Adinia, Siti Azirah Adonia (2021). The
influence of managerial characteristics on external financing preferences in
smaller enterprises. The case of Malaysian micro-sized enterprises.
Mukherjee, Tutun & Sen, Som Sankar. (2018). Sustainable Growth Rate and Its
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Rahim, Norfhadzilahwati. (2017). Sustainable Growth Rate And Firm Performance: A
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10.15388/Ekon.2019.2.6.
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SMES: A REVIEW FROM THE MALAYSIAN PERSPECTIVE.
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