## What is Internal Growth Rate Formula?

The internal growth rate is the rate of growth that the company can attain only with the help of its internal operation. This is the growth rate attained by the company without taking into effect the impact of any financial leverage in the form of debt funding. The formula for calculating the internal growth rate is a return on assets of the company multiplied by the retention ratio of the company. Return on assets for a company is calculated by the net income of the company divided by the total assets of the company.

Total assets include all the short term and long term assets of the company which the company acquires and deploys in order to run and expand its business operation. Retention ratio is the percentage of earnings that the company retains for its use and future growth of the company. Retention amount is the residual amount after the amount paid from earnings as a dividend.

Mathematically, it is represented as,

**Internal Growth Rate Formula = ROA * RR**

Where

- ROA= Return on Assets
- RR= Retention ratio

### Explanation

This ratio signifies for a company that how much the company can grow sustainably in the future with the number of earnings it is generated with the help of the normal course of business. It is the operational growth rate, achieved without taking into consideration the borrowed funds in the form of debt by the company. That’s why this ratio is considered to be internal as this much the company will be able to grow even without taking any outside debt investments.

It is the growth achieved by a company with the help of the earnings it decides to retain after distributing the amount of money the shareholders in the form of a dividend. An analyst looking at this ratio will look for a higher ratio as it signifies a better future prospect for the company.

### Examples of Internal Growth Rate Formula (with Excel Template)

Let’s see some simple to advanced examples to understand this ratio better.

#### Example #1

Let us do the calculation of the internal growth rate for two arbitrary companies. For the calculation, we need a return on assets of a company and retention ratio which is calculated by deducting the dividend amount payable from the earnings of the company and dividing that numerator by net income available to the shareholders.

Let’s assume some numbers in the table below for two companies.

For the calculation of internal growth rate first, calculate the following value,

**Retention Ratio for Company A**

- Retention Ratio (RR) = 1- (dividends paid/earnings)
- =1-(3/5)
- =0.40

**Retention Ratio for Company B**

- Retention Ratio (RR) =1-(3.5 / 6)
- =0.42

**Return of Assets for Company A**

- Return of Assets = $65/$140
- =46%

**Return of Assets for Company B**

- Return of Assets = $70/$155
- =45%

Therefore, the calculation for company A is as follows,

- IGR Formula = 46% * 0.40

**Internal Growth Rate for company A**

- IGR = 18.6%

**Internal growth rate for company B**

- IGR Formula = 45% * 0.42
- = 18.8%

We can see from the above example that the growth rate for the company B is higher than internal growth of the company A. This implies that the company B is able to grow through earnings from operations more than the company A. The internal growth does not take into account the effect of the growth from debt funding.

#### Example #2

For the calculation of growth rate of Reliance Industries, we need a return on assets for the company and retention ratio which is calculated by deducting the dividend amount payable from the earnings of the company and dividing that numerator by net income available to the shareholders.

The table below depicts the dividend, earnings per share and the return on assets for reliance industries.

For the calculation of internal growth rate first, calculate the following value,

**Retention ratio**

- Retention ratio for Reliance Industries = 1- (6/56) =.89

Therefore, the calculation of growth rate of Reliance Industries is as follows,

- IGR Formula = 8% * 0.89

- IGR = 7.1%

Higher the growth rate better it is for the company, the ratio signifies for a company that who much the company can grow sustainably in the future with the amount of earnings it is generated with the help of normal course of business. The ratio for reliance industries signifies that reliance industries are able to grow by 7.1% with its internal operational income.

#### Example #3

For the calculation of growth rate of TATA steel, we need a return on assets for the company and retention ratio which is calculated by deducting the dividend amount payable from the earnings of the company and dividing that numerator by net income available to the shareholders.

The table below depicts the dividend, earnings per share and the return on assets for Tata Steel.

For the calculation of internal growth rate first, calculate the following value,

**Retention Ratio for Tata Steel**

- Retention ratio = 1 – (9.4 / $75)
- =0.87

Therefore, the calculation of growth rate of Tata Steel is as follows,

- IGR Formula =13% * 0.87

**Internal growth rate of Tata Steel will be –**

- IGR = 11.4%

### Internal Growth Rate Calculator

You can use the following Internal Growth Rate Calculator.

ROA | |

RR | |

Internal Growth Rate Formula | |

Internal Growth Rate Formula = | ROA x RR | |

0 x 0 = | 0 |

### Relevance and Use

This ratio is very important to find out the future prospect of a company. Analysts who analyze the company keep a very close look at the ratio. The ratio is arrived at by using two very important parameters which the return on assets of the company. And the second variable used for calculating the internal growth rate is the retention ratio.

If a company is maintaining a higher level of retention ratio it signifies that the company has future growth prospect and is confident of generating a higher return with the money it is willing to retain. The internal growth is the rate that the company attains with the help of the earnings it decides to retain.

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