# What is Growth Approximation? Why is the Gordon Growth Model Important?

Analysing your company's monthly revenue is essential as it will help you understand the momentum of the company and adapt to growth strategies accordingly. Monitoring the growth of a company in various ways will offer a clearer view of the business's insights and lead to better decision-making.

It is vital to understand a company's growth rate, and you must know how to calculate the growth percentage. For businesses, it is essential as it will help them understand the value of their investments and assets.

Calculating the growth rate can help you measure the percentage of change occurring with time. This blog will discuss the growth approximation methods in detail. If you want to make a career in enrolling in a credible accounting course can help you understand the intricacies and applications of growth approximation.

## What are growth rates?

Growth rates can be defined as the percentage change of a specific variable within a particular period. These rates can be either positive or negative, depending on if the size of the variable increases or decreases with time.

Calculating growth rates can help you understand how an investment is performing with time. This information can be used to make reasonable, accurate predictions of the revenues that you can expect from the assets and investments.

By calculating and monitoring your company's growth rate, you can either decide to continue with the current investment plans or switch to a different strategy depending on the organisational goals.

## How to calculate the growth rate?

The growth rate of an organisation can be calculated with the following steps:

• Pick a metric: You can choose to calculate the growth rate of several different metrics, such as market share, revenue, and user growth rate. Choose the metric that you would like to focus on.
• Find a starting value: Choose a period for which you would like to calculate the growth rate. Select a starting value - this will represent the business's performance at the time.
• Find an end value: Now that the period is decided, you can choose what you want to be the final value. This would likely be a present value or a value indicating the business's performance at the end of that period.
• Apply the formula: Here are the two growth rate formulas that you can apply:
1. (Final value/starting value) x 100% = growth rate
2. (Starting value - final value)/starting value = growth rate

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## Different methods to measure the growth rate of a business

The following factors can be used to calculate a company's growth rate:

### Revenue growth

It can be calculated by checking if the sales of your business have increased or decreased over the past few quarters or years. The revenue percentage shows how much the company's revenues have shrunk or expanded over a given period.

Calculating this question on a monthly, quarterly, or yearly basis can help you understand the positive and negative changes that are affecting your company and its financial health.

### Market share growth

Market share is the portion of the market that the company or its products control. In order to find an organisation’s basic market value and to calculate the market share growth rate, it is vital to find the market size and the total sales revenue.

Calculating the market share growth will help you decide if the business will be sustainable in the long run and build the right strategies to improve sales.

### User growth rate

Calculating this can help you understand the number of new paying customers the company has gained per month.

A positive trend will indicate that the company's products appeal to the target customers and ensure that the marketing and sales strategies are working. If there is a negative user growth rate, it might indicate that you need to change or improve your technique and products.

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## What is the Gordon Growth Model (GGM)?

The GGM is a formula used for determining the intrinsic value of a stock depending on a future series of dividends, which grow at a constant rate. Using this simplified stock valuation method, investors are able to compare the businesses against other industries.

## Assumptions of the GGM

The Gordon Growth Model assumes the following conditions:

• The organisation keeps growing at a constant and unchanging rate
• The organisation’s business model remains stable
• The organisation has stable financial leverage
• The free cash flow of the organisation is paid as dividends.

## How to calculate the Gordon Growth Model (GGM)?

The GGM is used for calculating a stock's fair value. It is done by examining the relationship between three variables, which are as follows:

• Dividends Per Share (DPS): The value of the dividends next year.
• Dividend growth rate (g): Expected constant growth rate
• The required rate of return (r): Constant equity capital cost of the company

Therefore, the Gordon Growth Model = DPS / (r - g)

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## Importance of the Gordon Growth Model

This model can be used to find the relationship between discount rates, growth rates, and valuation. The model attempts to calculate the fair value of a stock irrespective of the current market conditions. It takes into consideration the market's expected returns and dividend payout factors.

In case the value that is obtained from the model is greater than the trading share prices currently, then the stock is undervalued and qualifies for a buy, and vice versa. The GGM is ideal for companies with a consistent track record of profitability.

### Limitations of the Gordon Growth Model

The main drawback of this model is the assumption of dividends constant growth per share. It is very unlikely for companies to have continuous growth in their dividends because of business cycles and unexpected financial success or difficulties. This model is thus best suited for organisations showing stable growth returns.

#### Conclusion

The growth rate of a company is a measure of its annual change in a variable expressed as a percentage. Positive growth rates can indicate that the variables are increasing with time, while negative growth rates mean that they are decreasing. Calculating your company's growth rate can help you assess its performance and predict future trends.

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