Determining sustainable growth.At its quarterly partner's meeting, the managing partner of a surgical group celebrates the group's continuing growth. With great pride in his voice, he announces the business has grown over 35 percent in the past year. However, when the chief financial officer comes forward to speak, she states the group must halt its growth rate or be prepared to forego bonuses or borrow money. The partners are surprised. The managing partner declares, "How is this possible? I thought growth was good for a business!" [ILLUSTRATION OMITTED] Many businesses, both small and large, have fallen into the trap of unbridled growth. We tend to think, "bigger is better," but is too much growth a bad thing? How do we know when to stop growing? The answers lie in understanding the concept of sustainable growth. It takes money to grow a business. As business increases, so does the need for additional assets to support the growth in business. If growth exceeds the financial resources necessary to fund the increase in assets, cash flow may be impeded im·pede tr.v. im·ped·ed, im·ped·ing, im·pedes To retard or obstruct the progress of. See Synonyms at hinder1. [Latin imped , resulting in unsustainable growth, and in some cases-eventual bankruptcy. Simply stated, the rate of sustainable growth determines how much a business can grow without compromising its cash flow or having to borrow funds. How do you determine the sustainable growth rate Sustainable growth rate Maximum rate of growth a firm can sustain without increasing financial leverage. ? If you look to a financial textbook for the answer, you will see the sustainable growth rate (SGR SGR Sustainable Growth Rate SGR Societa' di Gestione del Risparmio (Italian: Investment Management Company) SGR Specific Growth Rate SGR Surgeon General's Report SGR Soft Gamma-ray Repeater ) is equal to the return on equity (ROE) multiplied by one minus the dividend payout rate (SGR = ROE X (1-dividend payout). Since most medical practices are privately held, you can assume there is no dividend payout. The result is that the SGR equals the return on equity. Return on equity is a measure of operations and investing activity. It is determined by the return on assets Return on assets (ROA) Indicator of profitability. Determined by dividing net income for the past 12 months by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net income/sales) multiplied by asset utilization (sales/assets). (ROA ROA See: Return on assets ROA See: Right of accumulation ROA See return on assets (ROA). ) and the total asset turnover (ROE = ROA X total asset turnover). A simpler way to break this down into components that make sense for a medical practice is to estimate the ROE and SGR using measures readily available to medical practices, namely profitability, variable assets and variable liabilities. The formula is expressed as: SGR = [net profits %]/[[[Variable assets]/Billings] - [[variable liabilities]/Billings] - net profits] The first step in estimating the sustainable growth rate by this method is to calculate the surgical practice's net profit after taxes as a percent of its billings. For example, if the billings are $20 million and the net profit $400,000, then net profit after taxes as a percent of billings is 0.02 or 2 percent. This assumes all profits are retained in the practice and are not distributed as bonuses. The next step is to determine variable assets and variable liabilities as a percentage of billings. Variable assets are those that vary with the volume of billings. For a medical practice, the accounts receivables accounts receivable n. the amounts of money due or owed to a business or professional by customers or clients. Generally, accounts receivable refers to the total amount due and is considered in calculating the value of a business or the business' problems in paying would constitute the largest component of variable assets. If the surgical practice had an accounts receivable balance of $5 million on its billings of $20 million, then its variable assets as a percent of billings are 25 percent ($5million/$20 million). Similarly, variable liabilities include accounts payable and any expenses accrued but not paid. They would not include any long-term notes. If the surgical practice's variable liabilities were $2 million on $20 million of billings, then its variable liabilities as a percent of billings are 10 percent ($2 million/$20 million). Using these calculations, you can then estimate the sustainable growth rate for the surgical practice as follows: SGR = [0.02/[0.25 - 0.1 - 0.02]] = [0.02/0.13] = 0.15 = 15% As the chief financial officer correctly stated, if the group continues to grow at its current rate of 35 percent, it will exceed its sustainable growth rate of 15 percent. If unchecked, eventually the current rate of growth will outstrip out·strip tr.v. out·stripped, out·strip·ping, out·strips 1. To leave behind; outrun. 2. To exceed or surpass: "Material development outstripped human development" the group's assets, forcing it to seek alternative funding. [ILLUSTRATION OMITTED] How important is understanding and calculating a sustainable growth rate for a business? It is important enough for Congress to mandate in the Balanced Budget Balanced budget A budget in which the income equals expenditure. See: budget. balanced budget A budget in which the expenditures incurred during a given period are matched by revenues. Act of 1997 that Medicare not exceed its calculated sustainable growth rate in payments to physicians. Unchecked growth can be a disaster for any organization, whether public or private. The lesson is that growth can be good, provided you understand the interrelationship in·ter·re·late tr. & intr.v. in·ter·re·lat·ed, in·ter·re·lat·ing, in·ter·re·lates To place in or come into mutual relationship. in between growth, the assets needed to support growth and the liabilities required to fund the assets. Determining the sustainable growth rate allows you to understand these relationships and to ultimately maintain a financially healthy and viable business. By David Tarantino MD, MBA MBA abbr. Master of Business Administration Noun 1. MBA - a master's degree in business Master in Business, Master in Business Administration David P. Tarantino, MD, MBA, is the executive medical director of Shock Trauma Associates, P.A., a 50+ physician, multispecialty practice associated with the University of Maryland University of Maryland can refer to:
LLC - Logical Link Control , a health care management consulting Noun 1. management consulting - a service industry that provides advice to those in charge of running a business service industry - an industry that provides services rather than tangible objects firm in Baltimore. He can be reached by phone at 410-328-2036 or by e-mail at mdcg@verizon.net |
|
||||||||||||||||||||

Printer friendly
Cite/link
Email
Feedback
Reader Opinion