As expected, the SGR for Coke is higher as it assumes the business will
continue to raise debt proportionate with retained earnings in order to buy new
assets with both equity and debt. With assets being 455% of equity at Coke, the
business is highly leveraged and thus can achieve a nice SGR of 4.5% from any
retained earnings. This high level of leverage is also witnessed by ROE being
much higher than ROA. This 11% implies that the company can achieve a maximum of 11% growth without external financing. The retention Ratio is the rate of earnings that a company reinvests in its business. In other words, the remaining amount after paying dividends to shareholders represents the retention rate.

The internal growth rate (IGR) refers to the sales growth rate that can be supported with no external financing. As such, the company is funding its operations solely from retained earnings. A company’s maximum internal growth rate is the highest level of business operations that can continue to fund and grow the company. A company’s internal growth rate is the growth that can be achieved without issuing additional equity or debt financing. Internal growth is achieved using only retained earnings not paid out as dividends to invest in new assets.

Internal Growth Rate Calculator

Any business can generate an excellent internal growth rate if it can efficiently use its resources. When we say efficient manner, the company should try to maximize its efficiency by utilizing the resources and minimizing the waste and idle periods. The main driver for the internal growth rate is the reinvestment earnings. If a company can make its operations efficient, thereby increasing its profits and reinvesting those profits to grow, it can achieve an excellent internal growth rate of Return.

Think of your earnings as a pie where part of the pie gets distributed to owners and the rest stays with the company. In our example, 25% of the earnings were distributed so that left 75% of the earnings – and cash – in the company. Let’s use an example company with $4 million of net income that distributes $1 million of that to the owners. Their distribution rate is the $1 million of distributions divided by $4 million of net income, which equals 25%.

Internal Growth Rate (IGR) vs. Sustainable Growth Rate (SGR)

The company also warehouses finished goods that are sold to sporting goods stores, and management makes changes to reduce the level of inventory carried in the warehouse. These changes increase Acme’s efficiency and reduce the amount of cash tied up in inventory. This point would be when the business is unable to grow anymore solely from the cash flows it generates internally. 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. 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.

Internal growth involves using the business’s retained earnings to operate and drive growth. Return on equity is a measure of financial performance that calculates how much income is generated with the shareholder’s funds of the company. Also, similar products can share assets, which increases net income and, in turn, increases ROA.

Resources

Finally, add the SGR formula in an empty cell by multiplying the retention rate by the return on equity. The Rule of 40 is specific to SaaS companies, and uses growth rate and profit margin as key indicators for sustainable growth. Now that you have the retention rate, you need to calculate the return on equity. In an empty cell, type in the equal sign and add the formula using cell references. A plow back ratio is a ratio that measures the amount of earnings that are retained by a company after it has paid out dividends to shareholders. A new product line can also be added to the firm’s existing product base to generate sales and reduce market risk.

Grab the fill handle and drag right to get the sustainable growth rate for Company B. This is right around my 3% rule of thumb for a strong and mature company that should
be able to grow with the economy. Any growth rate needs to be compared to GDP
and growth rates well above the long-run rate of GDP (ie. internal growth rate formula +3%) should be considered
only short to medium term. In order to grow above the rate of GDP growth and
inflation in the long-term, a company needs to have a big economic moat to fend
off competition. Yes, it is a percentage showing the rate at which the business can grow without external financing.

Internal Growth Rate

Acme analyzes its production process and makes changes to maximize the use of machinery and equipment and reduce idle time. Unlike the IGR, the sustainable growth rate accounts for external financing. But the external funding sources are constrained to its existing capital structure. In a nutshell, the internal growth rate is one of the key parameters businesses need to analyze and consider when analyzing their internal growth potential. Still, companies can choose external financing if they have an excellent project to help them achieve greater heights. The internal growth rate is designed to give you the maximum amount of growth income your company can reasonably generate on an annual basis.

To calculate the internal growth rate, first step is to multiply the return on asset with retention ratio. Divide the first and second step and multiply the resultant value with 100. Sustainable growth is the growth rate that the company can grow using only debt financing but with the same capital structure. In other words, sustainable growth is the growth rate that the company can grow using debt but with the same debt to equity ratio. Debt is also added, but only to the extent, the debt to equity ratio does not change.