What Is an Internal Growth Rate (IGR)?

The internal growth rate (IGR) is the maximum rate at which a company can grow organically without needing to raise any additional capital from external sources. A firm's maximum IGR is the level of business operations that can continue to fund and grow the company. A company's IGR is important because it helps investors and analysts understand how a company can grow using its own capital resources. It can also be used to determine the soundness of a company's financial decisions.

Formula and Calculation of IGR

To calculate a company's IGR, you have to determine two variables. First, you need the company's return on assets (ROA), which is:

$\begin{aligned}\text{Net Income}\div\text{Total Assets (or average of total assets across periods)}\end{aligned}$Net Income÷Total 𝕴Assets (or average of total assets across periods)​

Then, you need its retention ratio (RR), which is the percentag𓆉e of how much net income is 🅘kept by the company:

$\begin{aligned}\text{Retained Earnings}\div\text{Net Income}\end{aligned}$Retained Earnings÷Net Income​

You can use these to calculate the IGR:

$\begin{aligned}\text{Return on Assets}\times\text{Retention Ratio}\end{aligned}$Return on Assets×Retention Ratio​

So, imagine Company A had the following data in𓄧 its financial statements:

• Net Income: $30,843,000
• Total Assets (or average of total assets across periods): $114,938,000
• Retained Earnings: $1,358,000

Now we can🀅 plug these figures in to determine each step:

• Using the formula for ROA ($30,843,000 ÷ $114,938,000), you get 0.27.
• The retention ratio ($1,358,000 ÷ $30,834,000) results in 0.04.

Then, you multiply the ROA a𝓡nd RR to get your IGR:

$\begin{aligned}0.27\times0.04=0.01, \text{ or } 10\%\end{aligned}$0.27×0.04=0.01, or 10%​

Alternate Formulas

You might see other way♕s to calculate the IGR using an alternate retention ratio. In this method, you subtract a company's dividend payout ratio from one:

$\begin{aligned}\text{Retention Ratio}=1-\text{Dividend Payout Ratio}\end{aligned}$Retention Ratio=1−Dividend Payout Ratio​

To use this method, a company must be profitable enough to pay dividends and have a dividend 澳洲幸运5官方开奖结果体彩网:payout ratio (Dividends Paid ÷ Net Income). Keep in mind that if the 澳洲幸运5官方开奖结果体彩网:dividends paid equals zero, your retention ratio, and thus your IGR,🤡 will be inaccurate.

For instance, if you used꧑ this method in the previous example with a company that has no dividends, you'd have a retention ratio of zero and would get an IGR of 0.27 (27%), whereas previously, you got a result of 0.01 (10%):

• ROA: 0.27
• RR: 1 - 0 = 1
• IGR: 0.27 x 1 = 0.27 or 27%
  

Fast Fact

Other important growth rates include the sustainable growth rate and the 澳洲幸运5官方开奖结果体彩网:compound annual growth rate (CAGR).

Limitations of Using the Internal Growth Rate

The IGR may indicate the maximum growth that a company can experience using only its existing resources (no external funding, retained earnings only). While this metric is useful to companies that can retain earnings, most companies don't become profitable for many years. Without profitability, there may be no retained earnings, which can pose further dif🐓ficulties if business owners want to use IGR 💫as an analytical tool.

Investors may not find much value in the IGR because of the issues mentioned previously—no dividends or retained earnings means the rate cannot be calculated. Because companies that have retained earnings and pay dividends are generally more mature, the IGR may not be a compelling analysis metric.

The IGR is also vital to business growth—the retained earnings figure represents capital sitting in an account. A company shouldn't have very large retained earnings because capital is being wasted. If a c🍎ompany's retained earnings grow, it might mean it is more profitable and reinvesting its earnings. This may also mean that the company is sitting on capital that could be put to use.

What Is the Difference Between Internal and External Growth Rate?

Internal growth is when 🥃a company uses internal resources to grow, while external growth is when it uses resources from outside itself to grow.

Which Is Higher Internal Growth Rate or Sustainable Growth Rate?

Susꦛtainꦓable growth rate is always higher than an internal growth rate because it factors in leverage, or debt.

What Is the Internal Growth Rate Formula?

The formula for the internal growth rate i🐻s (Retained Earnings ÷ Net Income) × (Net In🌄come ÷ Total Assets).

The Bottom Line

The internal growth rate is a measurement some business owners and investors use to gauge how much growth a business can experience using only internal sources. It can only be used to evaluate companies that generate enough revenue to retain earnings or issue dividends to stockholders.


Correction—Aug. 24, 2023: A previous version of this article used only the dividend payout ratio to calculate the internal growth rate. As the article now correctly states, there are two different ways to calculate it depending on the company's status.