Did you know that there's a formula that you could apply to determine the sustainable growth rate of a business? Now, I know you may be thinking, whippity-doo-dah, Steve, sustainable growth rate, that's for the birds and the nerds, but here's why it's important. You can grow a business pretty easily, but you can also grow a business really quickly into bankruptcy court if you don't understand this important formula. It's very easy to compute.

I'm going to give you a calculator so you can do it on your own and you can apply it to any business that you're working in, and it's really critical to understand, especially if you're a business owner or you're a leader responsible for driving growth in a business and you want that business to be around. Years ago, I had a business owner come to me. He's like, Steve, let's dump the gasoline on this company, not literally, but metaphorically, because he had experienced some real success up to that point and he wanted to just amplify it.

So he wanted to grow the business and he wanted to grow the business really quickly. And I was like, hold up. Okay, before we go down that path, let me build out a financial model, right? Because that's what I do. I love building out financial models. I'm a nerd like that, I guess. So I build out this financial model and I show him the number, and I can't remember the exact number off the top of my head, but it was something like 25%.

And I came back to him, I was like, look, I know you want to 10X this business, but if you grow the company faster than 25%, you're going to have to raise X amount of capital. And that's what the sustainable growth rate will give you. It will tell you how fast can you grow the business without giving up equity for cash or going out and raising some debt.

So let me show you how this works. I'm going to give you the long form, right? And then I'm going to give you the shortcut, and I'm going to tell you how you can get this calculator and mess with it and apply it to your business. All right? So here's the long form.

So you understand the mechanics. When it comes to your sustainable growth rate, it is equal to your return on invested capital. Okay. I'm going to get a little technical with you here for a second, but follow me. Return on invested capital times one minus your payout ratio. All right.

Before you panic, let's break that down in a very simplistic manner. I don't want you to fall off the treadmill or drive off the road here. So let me try to be very clear and succinct.

When it comes to your return on invested capital, what that means is how much are you earning based on the amount of money you have tied up in your business, all the invested capital in your company. In other words, all the money that's in working capital and purchases like trucks, trailers, tractors, buildings, et cetera, to run your business. That's your invested capital, just from a high level.

Okay. So it's how much net operating profit after tax are you earning based on the amount of money you have invested in your business? So I'll say this multiple times in multiple ways to be redundant on purpose. So this really sticks.

Okay. So let's go even deeper on this. Let me get a little bit more technical. So return on invested capital, the formula is NOPAT, which stands for net operating profit after tax. In other words, how much profit do you earn from the core of your business, from the operations of your business after taxes? All right. So we take NOPAT divided by invested capital.

And I told you before that invested capital is working capital, current assets, minus current liabilities, plus your net property plant and equipment. You can find those three items on your balance sheet, current assets, current liabilities, and net property plant and equipment. Now I'm going to go even more technical for those of you who want the details.

Current assets should exclude excess cash and current liabilities. Make sure you exclude interest bearing debt. We don't want to account for those in our invested capital calculation. Okay. So you could go to your balance sheet, current assets, minus current liabilities, that will give you your working capital. And then look at your net property plant and equipment, which is your gross property plant and equipment, less accumulated depreciation.

All right. Those numbers you'll need in conjunction with your net operating profit after tax. Here's the caveat.

Okay. When you're looking at your income statement, if you're an LLC or you're an S corporation, your business does not pay taxes. In other words, you have income before taxes, but then that income flows on to the personal tax return of the owner through a K1. And the owner or the owners of the business cover the taxes. In other words, the entity itself doesn't pay taxes, but you need to calculate that because somebody pays taxes. So therefore I just apply an effective tax rate.

And since some businesses that we work with, they have a lot of owners and they all have different tax rates and different tax situations. I'll just apply like 30% or 35%, just depending on the situation. All right. So let's just apply 30% to operating profit. So you take your operating profit times one minus your tax rate, the 30%. That's how you come up with net operating profit after tax.

Divide that by your invested capital and you get return on invested capital. Okay. Hopefully you're still with me and you didn't pass out because of all the complexity and all the formulas and the jargon I was spitting at you, but nonetheless, come back.

Okay. Come back for a minute. Return on invested capital. Like I said, it's the return that you earn on the capital that you have invested in your business. Here's a rule of thumb. When I look at the stock market for the last, say 50 years in the United States, it's returned on average, like nine to 10%. We'll just say 10% for easy math. Therefore, when I look at a business and when I'm with a company, I like to drive that number return on invested capital above 10%. All right.

Some businesses we start working with, they have a 6% return on invested capital. And I joke with the owner, like joking, but serious, like ha ha ha, but I'm serious. I say, look, you're better off just taking your money and putting it in the stock market because you can earn a 10% return on your money by investing in just a diversified portfolio of stocks.

Now there's so many nuances and I'm not saying you should close down your business or I'm not trying to shame you or make you feel bad if your return on invested capital is low. My point is, is that if you're running a business and you're not monitoring your return on invested capital and you're just looking at your income statement, you're missing the picture because your income statement will show you how much profit you earn, but it doesn't show you how much profit you earn relative to how much money you have tied up in the business. So that's why I like to look at return on invested capital.

So we have return on invested capital. We want to see that above 10% and essentially that is the first part of the sustainable growth rate formula, return on invested capital. Okay.

But then we have to account for dividends and distributions, because if you take money out of your business, you're an LLC or you're an S corp, for example, or even if you're a C corp and you take dividends and distributions, you're distributing the equity of the business. Okay. So we have to account for that in our formula because you have net operating profit after tax, but guess what? You distribute that, a portion of that through dividends and distributions, and that's known as your payout ratio.

So if you just take your dividends and distributions divided by your NOPAT, you'll come up with your payout ratio. So take return on invested capital times one minus your payout ratio, and you end up with your sustainable growth rate. Okay.

If I just hurt your head, I have great news for you because I made this so much easier for you. I created a calculator because just hearing me say it in my microphone, I'm like, oh my gosh, I'm probably confusing them like crazy, but nonetheless, thanks for sticking with me. All right.

So I took all these inputs. I created this calculator. You can get the calculator by going to Coltivar.com and on the website there, you will find the four-part Coltivar growth roadmap.

It's probably the best tool that we've launched out there to the market. And we spent a lot of time putting this together because we wanted to show people here's a roadmap of how to scale and here's a roadmap of how to scale correctly. There are so many talking heads and influencers out there that share growth hacks in business, but guess what? They don't talk about the limitations of growth if you don't have the right capital.

I mean, think about Shark Tank. If you've ever watched the show Shark Tank, somebody will come onto the show and they're like, growing the business to $5 million in revenue. And everybody applauds. They're like, oh, that's great. And then they're like, so what are you looking for? And they're like, I need $500,000 of cash in exchange for 20% of my business. And it's like, why are they willing to give up so much of their business or equity in their business whatsoever for cash? It's because to grow the business, you need cash, right?

So if you try to grow your business, if you're watching YouTube hacks, or you're listening to somebody who's like double your business, 10x your business, it's like, great. Do that without the capital to support it. And you'll just be bankrupt. That's a great plan. No, that's terrible, right?

So that's why I'm giving you the sustainable growth rate, because it'll tell you how fast you can grow without additional capital. And if you do need invested capital, guess what? The calculator will tell you roughly how much you need. Now, it's just a general rule of thumb. There's so many nuances to work through, but the calculator I think is pretty amazing.

So get the blueprint, download it. Like I said, it's at coltivar.com. Look in the show notes down below. I'll link that. And then go through the roadmap and there's the calculator. You can get the QR code, scan it. You can open up the calculator. You can use it as much as you want. It's totally free. You don't have to log in or do anything complicated. It's just right there. You plug in the numbers and then it'll spit out your growth rate and how much invested capital you need or don't need to grow your business.

So that's what I wanted to share with you today, because like I said, so many companies try to scale. They don't even know how fast they can scale. And they don't even know how to calculate that. And I wanted to make it very easy for all you listeners out there.

Okay. So if you're running a business, check that out and then let me know, what are your thoughts in the comments? Does this make sense? How do you look at growth? Do you just like wing it? Are you like, okay, we're just going to put everything we can into growth and hopefully we have enough cashflow to support it.

Or do you have a more scientific or methodical approach that you take? I'd love to hear your comments. Also, you can always DM me. I love the DMs that I get from the audience, from the community. I read every single DM and I try to respond in a timely manner. And same thing with the comments. If you leave a comment and you're listening on Spotify, you can just comment right in the box down below. It's like super easy.

All right. That's what I have for you until next time. Take care. Cheers.