Introduction to Finance

Dividend Policy
A reduction in the dividend payout ratio implies a higher retention rate 
and the ability for the fi rm to grow more quickly if all else remains constant. Thus, a quickly 
growing fi rm may decide to maintain a low dividend payout (thereby increasing its addition 
to retained earnings) in an eff ort to fi nance its growth. More mature, more-slowly growing 
fi rms usually increase their dividend payout (and have smaller relative additions to retained 
earnings) as growth opportunities diminish.
Profi tability
Higher ROAs generate more net income, larger additions to retained earn-
ings, and faster growth, when all else is held constant. Recall the equation used in the DuPont 
analysis in Chapter 14:
ROA = Profi t margin × Total asset turnover
Management can attempt to change ROAs by infl uencing these factors should growth outpace 
or fall short of the planned rate.
Capital Structure
The equity multiplier is determined by the fi rm’s fi nancing policy. A 
fi rm that uses a larger amount of debt can support a higher sustainable growth rate when all 
else remains constant. If growth exceeds the sustainable growth rate, a fi rm can fi nance the 
diff erence by taking on additional debt.
One or more of these variables must deviate from planned levels to accommodate a dif-
ference between planned and actual growth. If a fi rm’s growth exceeds the planned rate, man-
agement will have to reduce its dividend payout, increase profi tability, use more debt, or use 
a combination of these options. If growth slows, the fi rm will need to increase its dividend 
payout, reduce profi tability, reduce its use of debt, or choose a combination of these alternat-
ives. If outside fi nancing is needed, the external fi nancing needs calculation from Chapter 14 
can help estimate the amount of funds needed.
The fi rm’s ability to grow is aff ected by management’s strategy, by competitive condi-
tions, and by the fi rm’s access to capital and levels of additions to retained earnings. These 
infl uences of growth, dividend payout, and the amount of retained earnings determine the 
fi rm’s need for outside capital. We fi rst learned this in Chapter 14, when estimating a fi rm’s 
external fi nancing requirements.
As we saw then, a fi rm’s external fi nancing needs can come from short-term fi nancing sources, 
such as notes payable and reductions in lines of credit as well as spontaneous fi nancing sources, 
such as accounts payable. We reviewed infl uences on a fi rm’s short-term/long-term fi nancing mix 
in Chapter 16. In the next section, we’ll examine infl uences on a fi rm’s long-term fi nancing strategy.

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