Sustainable Growth under Inflation

pany is unable or unwilling to raise new equity, there exists only one growth rate in sales which is consistent with the maintenance of certain operating and financial ratios. This is the company's sustainable growth rate. When sales increase at a rate different from the sustainable growth rate, one ratio, or a combination of them, must change. Frequently, this means that companies must increase leverage to finance rapid growth. Nominal sales growth can come from two sources: increasing physical volume, and increasing prices. The earlier paper considered a case in which current assets increase in proportion to nominal increases in sales, concluding that inflation can exacerbate a company's sustainable growth problems. When the objective is to maintain a stable capital structure, as defined by the ratio of the total book value of liabilities to the book value of equity, inflationary growth substitutes in large part for real growth. So, if in the absence of inflation a company's real sustainable growth rate is 15%, the comparable figure in the presence of 10% inf tion might be only 8%. This s a sobering conclusion, for it implies that inflation may have a substantial depressing effect on economic growth. Companies experiencing difficulty financing growth in the absence of inflation will find that inflation forces them to choose between increased leverage or reduced real growth. To the extent that companies reduce real growth in response to falling sustainable growth rates, economic growth will suffer. This is essentially Lintner's message in 5. Johnson 4 extends my early work by distinguishing between the behavior of current liabilities and long-term liabilities under inflation. Johnson looks at a case where current liabilities vary with nominal sales, but where management constrains long-term liabilities to be a constant fraction of the book value of equity. She finds that in general the real sustainable growth rate under these conditions exceeds the one I found, and that in certain cases the real sustainable growth rate can be independent of the rate of inflation, or even vary inversely with it. The Johnson paper suffers from three problems. Just as I did, Johnson ignores the impact of inflation