Internal Growth Rate (IGR)Defined along with Formula & How to Calculate

Written By:
Lisa Borga

The internal growth rate refers to the greatest sales growth that a company can achieve without external financing.

This measures a company’s ability to fund its operations and grow solely off of its retained earnings.

This is a critical measure, particularly for small businesses and startups, because it shows the potential of a company to grow without further equity or debt funding.

Internal growth can be achieved through offering new product lines or expanding sales of existing products or services.

The IGR Formula

Internal Growth Rate = ((ROA × r) / (1 – (ROA × r))) × 100

Where,

ROA = Return on Asset

r = Retention Ratio

Calculating Internal Growth Rate

To calculate a public company’s internal growth rate, it is first necessary to use the formula for return on assets.

Return on assets is calculated by dividing the average total assets by net income.

After this, the retention ratio should be calculated. To do this, divide retained earnings by the business’s net income or take net income minus dividends and divide this by the net income.

After these two steps, the business’s internal growth rate can be calculated by dividing the business’s return on assets by its retention ratio.

Increasing the Internal Growth Rate

When a business is able to use its current resources in a more effective manner, it can achieve internal growth.

Suppose Jill’s Toys for Toddlers manufacturers dolls, toy vehicles, blocks, along with other toys for small children, and the business is analyzing its current operations.

After the business analyzes the production process, it decides to make some changes in order to maximize its machine usage as well as reduce its idle time.

The business also owns warehouses where it stores its finished goods before they are sent to its stores.

Jill’s Toys for Toddlers decides to reduce the amount of inventory it carries in its warehouses in an effort to increase its efficiency as well as reduce the amount of cash locked into inventory.

Jill’s Toys for Toddlers could also consider adding a new product line that would compliment what it is already selling.

One possible product line the business may add is educational electronic toys for young children.

The company already sells some non-electronic educational toys, and this new line of toys may appeal to customers who have purchased some of the educational toys it currently sells.

What Can Be Learned From the Internal Growth Rate?

The internal growth rate shows analysts the maximum sales growth rate that can be achieved solely through the use of retained earnings as a source of funding.

Companies may use the internal growth rate as a way to help determine how they may more effectively use their existing resources to efficiently achieve growth.

For a manufacturing company, this could potentially involve studying its current use of labor and machinery hours to minimize idle time and achieve maximum productivity.

In addition to potentially adding new product lines to achieve internal growth, a company may be able to optimize its selection of product lines.

For example, after studying its internal growth rate, a company may choose to eliminate a poorly performing line in order to focus its resources toward better performing or new product lines.

Uses of the Internal Growth Rate in Business Expansion

One way businesses tend to use an internal growth strategy is to try and increase their market share for products that they already sell, and there are a number of ways businesses can try to increase their market share.

If Jill’s Toys for Toddlers is able to achieve better marketing results, the business will then be able to sell more goods without increased expenses.

One way some businesses improve their marketing is by building better brand recognition.

The toy company could also try to come up with new products to sell to the customers it already has.

This can sometimes be easier than attracting new customers since the toy company’s current customers have already formed a relationship with the company and, therefore, might be more willing to try new products.

As an example, if Jill’s Toys for Toddlers already sells baby dolls, the business could add a baby stroller which it could sell to owners of the baby dolls.

The IGR will allow Jill’s Toys for Toddlers to see when it needs to find outside capital to expand its business.

This point would be when the business is unable to grow anymore solely from the cash flows it generates internally.

Key Takeaways

• The internal growth rate refers to the greatest amount of growth possible without securing outside financing.
• A given company’s maximum internal growth rate is the greatest attainable level of growth possible without securing debt or equity financing.
• Internal growth is possible through offering new product lines or expanding current offerings.