Updated: February 23, 2023
KEY TAKEAWAYS
- Internal growth rate (IGR) measures how a company can generate earnings and cash flow from its existing operations.
- Investors use the IGR to judge how efficiently a company is using its resources to generate growth.
- Organic growth is more sustainable than growth through acquisitions or other external financing.
What Is Internal Growth Rate (IGR)?
Internal growth rate (IGR) is a metric used to measure a company’s organic growth. It is calculated by multiplying the company’s retention ratio by its Return on Assets.
IGR is significant because it measures ability to grow without new customers or new investments. If a company has a high IGR, it means that it is able to generate enough revenue from its existing customer base to finance its maximum sales growth rate.
Internal Growth Rate Formula
Internal Growth Rate (IGR) is a measure of a company’s ability to generate growth from its own business operations. It’s calculated as follows:
The IGR is the net income percentage reinvested into the business to generate growth. It is a useful metric for evaluating a company’s ability to generate growth from its own operations. It is often used by analysts to compare companies within the same industry.
The IGR is typically higher for companies with strong profitability and low dividend payout ratios. Companies with high IGRs are able to reinvest a large portion of their earnings back into their business, which can fuel future growth.
The growth model is vital to measuring your success. You must ensure your internal growth rate is sustainable growth rate.
How to Calculate Internal Growth Rate
Internal growth rate calculation comes from the information in your company’s financial statements. Before you calculate internal growth rate, you must first compute the rate of return on assets (ROA) by dividing net income by total assets.
Then, you must determine retention ratio. You do this by dividing the reinvested (or retained) earnings by net income or subtracting out the dividend payout ratio from total of 1. The calculation of growth rate tells us that the income growth rate is now calculated by dividing the ROA by retention ratio.
How to Increase Your Internal Growth Rate
Increasing your internal financing usually comes from one of two growth drivers. The first is if you increase your earnings retention rate. Alternatively, a decreasing dividend payout ratio will also lead to an increase in IGR.
Second, if your return on equity increases, your internal growth rate increases. This is because ROA is a function of both your retention ratio and your profit margin. Both scenarios result in greater retained earnings.
Be warned that a poor business environment can have a negative effect on any future growth prospects. Thus, you need to monitor growth in sales and other activities.
With an internal growth strategy, you can increase your profitability without external factors. I.E., acquiring new customers or markets. Internal growth is all about making changes and improvements from within your company to drive profits higher.
Example of Internal Growth Rate
Let’s say Company A has a net income of $1,000,000 and pays out $200,000 in dividends. Our retention ratio would be:
Retention ratio = Net income – Dividends paid / Net income
Retention ratio = 1,000,000 – 200,000 / 1,000,000
Retention ratio = 0.8
Now let’s say that Company A has an average total assets figure of $4,000,000. ROA would be:
Return on assets = Net income / Average total assets
Return on assets = 1,000,000 / 4,000,000
Return on assets = 0.25
And finally, internal growth rate would be:
Retention ratio x Return on assets = IGR
0.8 x 0.25 = IGR
0.2 = IGR
This means the growth of Company A is 20%. This means that 80% of its net income is being reinvested back into the business to generate growth.
Summary
Internal Growth Rate (IGR) is a very important metric for businesses, especially small businesses. It is a measure of how quickly a business is growing without the need for external funding or investment.
IGR is an effective way to measure a company’s true growth income potential. By focusing on IGR, you can make better decisions about reinvesting profits and allocating resources.
When analyzing a company’s IGR, it is important to keep in mind the limitations of the metric. IGR does not take into account changes in revenue or capital structure. It also assumes that all profits are reinvested back into the business, which may not be the case in reality.
Despite its limitations, IGR is still a valuable metric for businesses to track. By understanding IGR and using it to make informed decisions, you can give your business a better chance at success.
FAQs About Internal Growth Rate
Can internal growth rate be negative?
Yes, internal growth rate can be negative. This usually happens when a company is not reinvesting its profits or when it is losing money. It means that the company is not growing and may even be shrinking. This can be a warning sign for businesses, and it is important to take action to turn the IGR around.
What is the difference between IGR and SGR?
IGR measures growth potential, while SGR measures actual growth. SGR is a more common metric. But IGR is more useful for businesses because it tells you how quickly a company can grow without external funding.
What is the difference between internal growth and external growth?
Internal growth is when a company grows without the need for external funding. This level of growth can be through reinvesting profits or through other means. External growth is when a company raises money from investors or takes on constant debt to finance growth
Sustainable growth rates are usually internal funds. This is because it does not rely on external equity financing. But businesses need to strike a balance between internal and external growth rates to be successful.
