How do you calculate the internal growth rate of a firm?


Quick Answer

The internal growth rate of a firm is calculated by subtracting its rate of earnings retention from its return on assets, according to Boundless. A company's return on assets is derived from dividing its net income by its total number of assets. Growth is not always favorable.

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Full Answer

The internal growth rate is the maximum growth a company can achieve without resorting to outside financing, explains Investopedia. The company must use all of its resources to sustain its general business operations and growth. It has no slack to take advantage of additional revenue opportunities.

Under such circumstances, growth can be detrimental to the enterprise, notes Boundless. The expansion may outstrip management's ability to effectively operate the company, possibly leading to decreases in efficiency and quality. For this reason, sustainable growth is often used as an alternative measure to internal growth rate. Sustainable growth is the annual percentage increase in sales possible within the defined financial policies of the firm. It is calculated by subtracting the rate of earnings retention from the return on equity. Return on equity is determined by dividing net income by shareholder equity. Unlike internal growth rate, sustainable growth rate assumes the company utilizes outside funding as prescribed in its financial policies.

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