Internal Growth Rate
It is the rate that signifies the maximum earnings of the company generated from the internal funding only, that is, earnings retained by the company after distributing dividends. The internal growth rate calculator assumes that no funds are raised through external sources.
It is more used in small businesses or initial stages of a business where the company does not have external borrowings. This shows the company’s capacity to perform and increase its turnover and profits without using external sources of funds.
Formula
Internal Growth Rate is obtained by multiplying the retention ratio by returns on assets. The formula for calculating the internal growth rate is:
Internal Growth Rate = Retention Ratio * Return on Assets
About the Calculator
This calculator will provide a quick result on inserting the following data into it.
- Retention ratio
- Return on assets
Calculator
How to calculate using Calculator
The user has to simply insert the following details into the internal growth rate calculator to get an instant result.
Retention Ratio
The retention ratio is the portion of earnings retained by the company after paying off dividends to the shareholders. The formula for calculating the retention ratio is:
Retention Ratio = 1 – Dividend Payout Ratio
Therefore, you can also use (1 – Dividend Payout Ratio) * ROA as a formula of internal growth rate directly instead of the formula mentioned above.
And the dividend payout ratio is the result of dividend per share divided by earnings per share. To know more about the dividend payout ratio, you can directly refer to our article – Dividend Payout Ratio. And you can also use our Dividend Payout Ratio Calculator for a quick calculation of the same.
Return on Assets
Return on assets is the ratio of net earnings of the company to its total assets. The formula is as follows:
ROA = Profit after Tax (PAT) / Total Assets
Click on the following article for more details on ROA – Return on Assets (ROA)
Example
Two companies, Micro Ltd. and Max Ltd., has net earnings of $20,000 and $25,000 after-tax payments, respectively, and both have distributed 75% and 77.5% of earnings as dividend among the shareholders. Total assets of both Micro Ltd. and Max Ltd. are $50,000
| Particulars | Remarks | Micro ltd. | Max Ltd. |
| Retention Ratio | 1 – Dividend Payout Ratio | 25% | 22.5% |
| Return on Assets | PAT / Total Assets | 40% | 50% |
Therefore, Internal Growth Rate of:
Micro Ltd. = 25% * 40% = 10%
Max Ltd. = 22.5% * 50% = 11.25%
Interpretation
A higher IGR is considered better as it means the company is generating more profits by utilizing the retained earnings. In the example above, Max Ltd. has a higher internal growth rate even though both the companies had the same amount of total assets. This means Max Ltd. is better at utilizing its funds even after paying more dividends than Micro Ltd. It also shows how far a company can grow on its own resources and the kind of profits/return it can generate. And if this rate of return is higher than the Risk-Free Rate of Return or relatively safe level of returns available in the market. Then it becomes preferable to deploy the funds more to the company rather than distributing them as dividends. And this will be beneficial for both the shareholders as well as the company.
Cautions
Internal Growth Rate provides an idea of efficiency in earnings by the company using internal sources, but no company or business can completely depend on its internal sources. It has to go for external borrowing. And in such a case, the internal growth rate is of no use or remains only relevant by exception. One should use a sustainable growth rate. It uses return on equity instead of return on assets.
