Key Takeaways
- Maximum growth using only retained earnings.
- Calculated as ROA multiplied by retention ratio.
- Shows organic growth potential without external financing.
- Useful for investors and management to gauge self-funded growth.
What is Internal Growth Rate?
The Internal Growth Rate (IGR) is the maximum growth rate a company can achieve using only its retained earnings, without relying on external financing such as issuing new equity or taking on debt. It reflects a firm's organic expansion potential based solely on reinvested earnings and asset efficiency.
Understanding IGR helps you evaluate how much a company can grow sustainably without increasing financial leverage or diluting shareholder value.
Key Characteristics
IGR reveals a company’s ability to fund growth internally. Key characteristics include:
- Organic growth measure: Focuses exclusively on reinvested profits, avoiding external capital sources.
- Calculated using ROA and retention ratio: ROA (Return on Assets) indicates efficiency, while the retention ratio shows earnings reinvested.
- Useful for smaller firms: Especially valuable to startups assessing growth without capital markets access.
- Conservative growth indicator: Unlike the sustainable growth rate, IGR does not factor in leverage, providing a baseline growth estimate.
- Linked to capital investment: Effective internal growth often depends on smart capital investment decisions.
How It Works
The Internal Growth Rate is computed by multiplying the company’s Return on Assets (ROA) by its retention ratio, which is the proportion of net income reinvested rather than paid out as dividends. This formula highlights how well the company uses its assets and retained earnings to fuel growth without external funds.
By focusing on ROA, IGR reflects the firm’s operational efficiency, while the retention ratio indicates how much profit is plowed back into the business. Companies with higher ROA and retention ratios will typically have a higher IGR, enabling them to grow faster organically.
Examples and Use Cases
IGR is widely used by investors and management to assess sustainable expansion capacity. Consider these examples:
- Airlines: Delta may use IGR analysis to determine how much it can expand flight routes using earnings alone without increasing debt.
- Growth stock selection: Investors looking for companies with strong self-funding ability can compare IGR among the best growth stocks.
- Mid-cap companies: Firms in the mid-cap stock category often rely on internal growth metrics to plan expansion before seeking external capital.
Important Considerations
While IGR provides valuable insights, it assumes constant retention ratios and asset growth rates, which may not hold during periods of rapid change. Also, it excludes the impact of financial leverage, which can boost growth beyond internal resources.
For comprehensive growth analysis, consider comparing IGR with metrics like sustainable growth rate and factor in accounting standards such as IFRS that affect reported earnings and asset values.
Final Words
Internal Growth Rate reveals how much your company can grow using only its retained earnings, avoiding external financing. Calculate your IGR to set realistic growth targets and identify when external capital might be necessary.
Frequently Asked Questions
Internal Growth Rate (IGR) is the maximum growth rate a company can achieve using only its retained earnings, without relying on external financing like debt or equity issuance.
IGR is calculated using the formula IGR = ROA × Retention Ratio, where ROA is Return on Assets (Net Income divided by Total Assets) and the Retention Ratio is the portion of net income retained in the company.
IGR measures a company's ability to grow organically without external funding, helping businesses understand their maximum growth potential using existing resources and retained earnings.
While IGR uses Return on Assets to measure growth based on internal earnings, Sustainable Growth Rate considers Return on Equity and includes the effects of financial leverage in growth potential.
Yes, investors use IGR to evaluate a company's long-term growth potential and its ability to self-fund expansion without diluting shareholders or increasing debt.
Calculating IGR assumes that all components like total assets and expenses grow at the same rate, the retention ratio remains constant, and there are no increases in accounts payable.
A high IGR indicates that a company generates enough profit from its current operations to finance significant growth without needing external capital, reflecting strong organic growth potential.
Both business managers and investors benefit from IGR; managers can optimize resource use to boost growth, while investors assess the company's ability to expand sustainably without external funding.
