How to Find a Company’s Internal Growth Rate

The Internal Growth Rate (IGR) indicates a company’s maximum growth potential without requiring external financing. This rate reveals how much a business can expand using only its internally generated funds, such as retained earnings. Understanding the IGR helps stakeholders assess a company’s financial health and its capacity for self-funded expansion.

Defining Internal Growth Rate

The Internal Growth Rate (IGR) represents the highest rate at which a company can grow its operations and assets using only its own resources. This growth is financed entirely through retained earnings, which are profits not distributed to shareholders as dividends, and without taking on new debt or issuing new equity. The IGR measures a company’s capacity for organic expansion based on its current profitability and asset utilization.

This metric helps financial planning by highlighting a company’s ability to achieve sustainable growth independently. A business with a strong IGR can reinvest its earnings back into the company, funding new projects, expanding operations, or upgrading equipment. It provides a clear picture of a company’s self-sufficiency in driving its own growth trajectory.

Essential Components for Calculation

Calculating a company’s Internal Growth Rate requires two financial metrics derived from its financial statements: Return on Assets (ROA) and the Retention Rate. These components provide insights into how efficiently a company uses its assets to generate profit and how much of that profit it reinvests.

Return on Assets (ROA) measures how efficiently a company uses its assets to generate net income. This profitability ratio is calculated by dividing a company’s Net Income by its Total Assets. Net Income can be found at the bottom of the income statement. Total Assets are listed on the balance sheet.

The Retention Rate indicates the percentage of a company’s net income that is retained and reinvested back into the business, rather than being paid out as dividends to shareholders. It can be calculated as one minus the dividend payout ratio, or by dividing retained earnings by net income. These figures can be found on the income statement, statement of retained earnings, or the cash flow statement. A higher retention rate means a company is holding onto a larger portion of its earnings for future growth initiatives.

Step-by-Step Calculation

Once the Return on Assets (ROA) and the Retention Rate have been determined, these values are integrated into a specific formula to calculate the Internal Growth Rate (IGR). The formula for the Internal Growth Rate is: IGR = (ROA Retention Rate) / (1 – (ROA Retention Rate)).

To illustrate this, consider a hypothetical company with an ROA of 15% (or 0.15) and a Retention Rate of 70% (or 0.70). First, multiply the ROA by the Retention Rate: 0.15 0.70 = 0.105. This product represents the earnings generated per dollar of assets that are retained for reinvestment.

Next, subtract this product from 1: 1 – 0.105 = 0.895. This step adjusts for the compounding effect of reinvested earnings on the asset base. Finally, divide the initial product (0.105) by this result (0.895): 0.105 / 0.895 ≈ 0.1173.

Therefore, the Internal Growth Rate for this hypothetical company is approximately 11.73%. This calculation demonstrates the direct relationship between a company’s profitability, its asset management, and its decision to retain earnings, all contributing to its capacity for internal expansion. The result provides a clear percentage representing the company’s maximum growth without external capital.

Interpreting the Calculated Rate

The calculated Internal Growth Rate percentage offers valuable insights into a company’s financial health and strategic capabilities. This percentage signifies the maximum rate at which a company can expand its sales and operations using only its internally generated funds, without the necessity of issuing new debt or equity. A higher IGR suggests that a company possesses a greater ability to fund its own growth initiatives through its retained earnings and efficient asset utilization.

Businesses can leverage this metric for strategic planning, understanding their inherent capacity for growth without relying on external financing. For instance, a company with a 10% IGR can anticipate growing its revenues and assets by up to 10% through reinvesting its profits. This informs decisions regarding reinvestment strategies, capital expenditure plans, and dividend policies. The IGR provides a benchmark for evaluating whether a company’s planned growth trajectory aligns with its internal funding capabilities, ensuring that expansion is pursued within sustainable financial parameters.