What Is an Internal Growth Rate (IGR)?

What Is an Internal Growth Rate (IGR)?

I'm going to explain the internal growth rate, or IGR, directly to you. It's the maximum rate at which your company can grow organically without pulling in any additional capital from outside sources. This means the highest level of business operations that can fund and expand the company using what it already has. As an investor or analyst, you should know that IGR shows how a company can grow with its own resources, and it helps evaluate the soundness of its financial choices.

Key Takeaways

Let me lay this out plainly: the internal growth rate is the top growth level your business can hit without outside financing. It's the operational level that keeps funding and growing the company without new equity or debt. You can generate this internal growth by adding new product lines or expanding current ones.

Formula and Calculation of IGR

To calculate IGR, you need two key variables. First, get the company's return on assets (ROA), which is net income divided by total assets—or the average of total assets over periods. Then, find the retention ratio (RR), which is retained earnings divided by net income. Multiply ROA by RR to get the IGR.

Take Company A as an example. It has net income of $30,843,000, total assets of $114,938,000, and retained earnings of $1,358,000. ROA comes out to 0.27 when you divide net income by total assets. The retention ratio is 0.04 from dividing retained earnings by net income. Multiply them: 0.27 times 0.04 equals 0.01, or 1%—wait, actually 10%, as corrected in the math.

Alternate Formulas

You might come across another way to figure the retention ratio by subtracting the dividend payout ratio from one. That's retention ratio equals 1 minus dividend payout ratio. This works if the company is profitable and pays dividends. But if dividends are zero, it skews things—your retention ratio becomes 1, leading to a higher IGR. For instance, in the earlier example without dividends, you'd get an IGR of 27% instead of 10%.

Limitations of Using the Internal Growth Rate

IGR shows the max growth from existing resources, relying on retained earnings. But many companies aren't profitable for years, so no retained earnings means you can't calculate it properly. Investors might not value IGR much for the same reasons—it's more relevant for mature companies with earnings and dividends.

Remember, retained earnings are capital that should be used, not just sit there. Growing retained earnings could mean profitability and reinvestment, but it might also indicate wasted potential.

What Is the Difference Between Internal and External Growth Rate?

Internal growth uses a company's own resources to expand, while external growth pulls in outside resources like financing or acquisitions.

Which Is Higher: Internal Growth Rate or Sustainable Growth Rate?

The sustainable growth rate is always higher because it includes leverage from debt.

What Is the Internal Growth Rate Formula?

It's (retained earnings divided by net income) times (net income divided by total assets).

The Bottom Line

In the end, IGR is a tool for business owners and investors to measure growth potential from internal sources only. It applies to companies that generate enough revenue for retained earnings or dividends.