The internal growth rate (IGR) is the maximum pace at which a company can expand using only internally generated funds — that is, retained earnings — without taking on new external financing (new debt or new equity). It is a useful, simple way to estimate how fast a business can grow while relying solely on profits that are kept in the company.
Key takeaways
– IGR measures the highest growth a company can fund from retained earnings alone.
– The IGR requires a profitable business that actually retains earnings; it cannot be computed meaningfully for companies with zero or negative net income.
– The basic IGR calculation combines the company’s return on assets (ROA) with its retention ratio (the share of net income kept, not paid out as dividends).
– The sustainable growth rate (SGR) typically exceeds IGR because SGR allows a company to use financial leverage (debt) while keeping capital structure constant.
– IGR is a snapshot based on current profitability and payout policy; it ignores operational or financial changes that may affect future ability to fund growth.
Formula and calculation of IGR (step‑by‑step)
Core concept: retained earnings (dollars available to reinvest) expressed as a share of total assets gives the portion of asset growth that can be funded internally. There are two equivalent ways commonly used to compute the inputs.
Step 1 — Calculate ROA (Return on Assets)
ROA = Net Income ÷ Total Assets
(Use average total assets if you want a period‑consistent ROA for a year.)
Step 2 — Calculate the retention ratio (RR, also written b)
Two equivalent methods:
– RR = Retained Earnings ÷ Net Income
OR
– RR = 1 − Dividend Payout Ratio, where Dividend Payout Ratio = Dividends Paid ÷ Net Income
Step 3 — Compute IGR (simple/common form)
IGR = RR × ROA
This is interpreted as the portion of asset growth the company can pay for with the retained portion of its profits.
Practical example
– Net income = $50,000
– Total assets (average) = $500,000 → ROA = 50,000 ÷ 500,000 = 0.10 (10%)
– Dividends paid = $10,000 → Dividend payout = 10,000 ÷ 50,000 = 0.20 → RR = 1 − 0.20 = 0.80 (80%)
– IGR = RR × ROA = 0.80 × 0.10 = 0.08 → Internal growth rate = 8%
Alternate formulas and variants
– Equivalent direct expression: IGR = Retained Earnings ÷ Total Assets (because Retained Earnings ÷ Net Income × Net Income ÷ Total Assets = Retained Earnings ÷ Total Assets).
– Some authors and formulas in finance texts present a variant with a denominator, e.g. IGR = (b × ROA) / (1 − b × ROA). That form appears in contexts where a different definition of “growth” is applied (for example, compounding relationships or when tying asset growth to sales growth under additional assumptions). Because conventions differ across sources, always check which formula is being used and what “growth” (assets, equity, or sales) it denotes before comparing results.
Fast fact
IGR can be computed purely from line items on the financial statements (net income, dividends, total assets), but it only tells you how much expansion the business could support using internal funds at current profitability and payout policy — it does not tell you whether that expansion is desirable or optimal.
Limitations of using the internal growth rate
– Requires positive net income and retained earnings: start‑ups or unprofitable firms may have no meaningful IGR.
– Static view: IGR is based on current ROA and payout policy; if margins, asset turnover, or dividend policy change, the IGR will change.
– Ignores investment opportunities and returns: just because funds are available doesn’t mean the company should deploy them; management may choose to pay dividends or make strategic acquisitions instead.
– Ignores leverage and capital structure effects: debt can raise the pace of growth beyond the IGR, which is why SGR (which permits maintaining leverage) is typically higher.
– May not reflect managerial choices to accumulate retained earnings unnecessarily (idle cash) or to keep a buffer for risk.
What is the difference between internal and external growth rate?
– Internal growth: growth financed only with internally generated resources (retained earnings). No new external equity or borrowings. IGR is the measure.
– External growth: growth financed with outside capital — new debt, issuing new shares, strategic alliances, mergers & acquisitions, or other external financing mechanisms. External financing lets firms grow faster than IGR, but introduces interest costs, dilution, or higher financial risk.
Which is higher — internal growth rate or sustainable growth rate?
– The sustainable growth rate (SGR) generally exceeds the IGR because SGR allows the company to maintain a target capital structure that includes debt (financial leverage) while financing growth. SGR typically measures the maximum growth rate a firm can sustain without changing its leverage ratio and while paying dividends consistent with its payout policy; because leverage can magnify returns to equity, SGR is usually higher than IGR. (Check the exact SGR formula used by a source — some present SGR = ROE × retention ratio; others include forms with denominators as noted above.)
What is the internal growth rate formula?
Primary (commonly used) form:
– IGR = Retention Ratio × ROA = (Retained Earnings ÷ Net Income) × (Net Income ÷ Total Assets) = Retained Earnings ÷ Total Assets
Alternate/variant forms you may encounter:
– Use RR = 1 − Dividend Payout Ratio when dividends are reported.
– Some texts use a different algebraic variant (e.g., (b × ROA) / (1 − b × ROA)) depending on what they define as “growth” and the modeling assumptions; be careful to confirm definitions before comparing metrics from different sources.
Practical steps to compute and use IGR (checklist)
1. Verify the company is profitable over the period of interest (positive net income).
2. Collect the numbers from the financial statements: net income, dividends paid, and total assets (or average assets for a year).
3. Compute ROA = Net Income ÷ Total Assets.
4. Compute retention ratio RR = 1 − (Dividends ÷ Net Income) or RR = Retained Earnings ÷ Net Income.
5. Compute IGR = RR × ROA (or Retained Earnings ÷ Total Assets).
6. Interpret: IGR is the percentage growth the firm can support using retained earnings alone at current profitability and payout policy. Compare IGR to management’s growth plans: if planned growth > IGR, external financing will be required.
7. Recalculate periodically: IGR will change as profitability, asset base, and dividend policy change.
The bottom line
The internal growth rate is a straightforward, statement‑based metric that estimates how fast a profitable company can grow by reinvesting earnings alone. It is most useful as a sanity check: if management plans growth that exceeds the IGR, the firm must raise external capital or change profitability/payout assumptions. Because IGR ignores leverage and other financing options and is sensitive to current accounting figures, it should be used together with other measures (SGR, cash‑flow analysis, capital budgeting) when assessing growth plans.
Source
– Investopedia, “Internal Growth Rate (IGR)” (article used as the primary source for definitions and practical steps). Correction note: Investopedia updated its presentation to clarify the two ways to compute the retention ratio (Aug. 24, 2023). Link
– Compute the IGR for a real company from its latest financial statements, or
– Compare IGR and SGR numerically for a sample set of assumptions so you can see how leverage changes the picture.