Inside Growth Rate (IGR): What Is It?
An internal growth rate (IGR) is the fastest rate of growth a business can achieve without getting outside funding. A company’s maximum internal growth rate is the rate of operations that can continue to pay for and grow the business.
Formula and How to Figure Out IGR
You need to know two things about a company to determine its internal growth rate. First, you must know the business’s return on assets (ROA). This is:
Net Income ÷ Total Assets (or the sum of all assets over time)
After that, you need to know its retention ratio (RR), which is the net income the company keeps.
Earnings Kept ÷ Net Income
Last but not least, you can figure out the IGR:
Money Back on Assets x Retention Rate
Let’s say that Company A’s financial records showed the following:
- $30,843,000 in net Income
- $114,938,000 in total assets, or the sum of all assets over time.
- $1,358,000 in earnings kept
When you divide $30,843,000 by $114,938,000, you get 0.27, the return on assets. By dividing $1,358,000 by $30,834,000, the retention rate is 0.04. Then, to get your IGR, you increase the ROA by the RR:
0.27 x 0.04 = 0.01, or 10%
Different Formulas
Using a different retention ratio, you might find other ways to figure out the IGR. To use this method, take a company’s profit-to-payout ratio and subtract it from one:
The retention ratio is one minus the dividend payout ratio.
Dividends Paid ÷ Net Income must be greater than 0 for this method, but the company must be profitable enough to pay dividends. It’s possible for your retention ratio and IGR to be wrong if the earnings paid are zero. As an example, if you used this method with the last company that doesn’t pay rewards (which means the retention ratio would be zero), you would get an IGR of 0.27 (27%), whereas before, you got a result of 0.01 (10%):
- ROA: 0.27
- RR: 1 – 0 = 1
- IGR: 0.27 times 1 equals 0.27, or 27%
The Internal Growth Rate Has Some Drawbacks
Some think the internal growth rate shows how much growth a company can achieve with its resources, like retained earnings and no outside funds. Remember that most businesses don’t start making money for many years. This measure is helpful for businesses that have reached a point where they can keep their earnings. Profitability is essential because, without it, there might not be any retained earnings. This can make it harder for business owners to use IGR as a tool for research.
Investors might not see much value in the IGR because of the problems we’ve already talked about. For example, the rate can’t be found since there are no dividends or retained earnings. The internal growth rate may not be a helpful analytical measure for companies that pay dividends and keep their earnings. This is because these companies are usually not in the startup or small business phase and are more mature.
Another problem with the IGR is that it is significant for business growth; kept earnings are just money sitting in an account. A business shouldn’t have a reserved earnings account that is too big, as it wastes money. When a company’s retained earnings go up, it could mean they are making more money and putting it back into the business. It could also mean the business has money it wants to use.
What’s the Difference Between the Growth Rate Inside and Outside?
An organization grows when it uses its resources to do so. On the other hand, an organization grows when it uses resources from outside its organization.
Which is better: the internal growth rate or the sustainable growth rate?
Because it considers debt, the sustainable growth rate is always higher than the internal growth rate.
How do I find the internal growth rate?
You can find the internal growth rate by adding the retained earnings and net Income. Then, divide the net Income by the total assets.
Conclusion
- An internal growth rate, or IGR, is the fastest rate of growth a business can achieve without getting money from outside sources.
- A company’s highest growth rate without taking on more debt or stock is called its “maximum internal growth rate.”
- Adding new product lines or growing current ones can lead to internal growth.
