Small business owner smiling at camera
Growing a business

Internal Growth Rate: What it Means for Your Company

As a small business owner, you're always looking for ways to grow your company. And while external growth (through marketing and sales) is essential, internal growth is just as crucial. After all, if your team isn't growing and developing, your company will eventually stagnate.

But what exactly is internal growth? And how can you measure it?

This article will define internal growth, teach you how to calculate internal growth rate using the internal growth rate formula, and illustrate the benefits internal growth strategies can bring to your business.

What is Internal Growth?

The internal growth of a business is the increase in the company's net worth over time and is one of the numerous types of business growth. When a company grows internally, it is usually because the company has reinvested its profits back into the business. This can take the form of expanding the business, hiring new employees, or investing in new technology. The goal of internal growth is to make the company more efficient and profitable.

Internal growth or "organic growth" is the increase in a company's sales and earnings generated internally through the reinvestment of its resources and profits. The main advantage of internal growth is that it allows companies to avoid the risks associated with external growth, such as mergers, acquisitions, and joint ventures. However, internal growth also offers several other benefits, discussed later in this article.

Three factors contribute to the internal growth of a business:

  • Profit margin: This is the amount of money a company makes on each sale, divided by the cost of goods sold. A high-profit margin means a company makes a large amount of money on each sale and grows internally.
  • Sales growth: This is the increase (or decrease) in sales from one year to the next. A company that's growing its sales is growing internally. Therefore, determine the maximum sales growth rate your business can handle and go from there. 
  • Asset turnover: This measures how efficiently a company is using its assets. It's calculated by dividing a company's sales by its total assets. The higher the number, the more efficient the company is and the more able they generate internal growth. 

What is Internal Growth Rate (IGR)? 

Several business metrics can be used to measure the success or progress of a company, and internal growth rate (IGR) is one of them. IGR measures how much a company grows from its operations without external factors such as mergers or acquisitions. It's an essential metric for businesses to track because it can show how strong the company's current internal operations are and whether or not it can create a sustainable growth rate. 

How to Calculate Internal Growth Rate 

The internal growth rate metric considers the return on assets (ROA), retention rate, and payout ratio to determine how much money the company makes from its operations. 

Return on assets measures how well a company uses its assets to generate profits. The higher the ROA, the better a company can generate profits from its assets.

The retention rate measures how much of a company's profits are reinvested into the business. The higher the retention rate, the more a company's profits are reinvested into internal growth.

The payout ratio measures how much of a company's profits are paid out as dividends to shareholders. This number can be used to understand how much the company reinvests into its operations. The lower the payout ratio, the more a company's profits are available for internal growth.

All of these factors are important in calculating a company's internal and sustainable growth rate. By understanding and measuring them, you can clearly see how well the company is growing from within. 

Calculate your company's internal growth rate by subtracting your company's liabilities from its assets and dividing by the number of years you've been in business. This will give you your annual growth rate.

Internal Growth Rate Formula 

There are a few different ways to calculate IGR. The most common is the revenue growth rate formula, which is:

IGR = (Revenue t – Revenue t-1) / Revenue t-1

Where "t" indicates the current period and "t-1" means the previous period.

Another way to calculate IGR is by using the earnings growth rate formula, which is:

IGR = (Earnings t – Earnings t-1) / Earnings t-1

There are also a few things to keep in mind when calculating IGR. First, the revenue or earnings used in the calculation should be from the same period. So, for example, if you're calculating IGR for Q1, you should use revenue or earnings from Q1 in your calculation. Second, make sure to use the correct currency when calculating IGR.

Finally, the third way a business can calculate its IGR is with this formula: 

IGR = (Net Income/Sales) x (1 - Retention Rate) 

This internal growth rate formula considers that a company's growth is not just a product of its profits but also how well it hangs onto its customers. The retention rate measures how likely customers are to return and do business with the company. 

What Does the Internal Growth Rate Tell You? 

The internal growth rate is an essential metric for businesses to track because it can show how strong the company's internal operations are. In addition, by tracking IGR, businesses can identify areas where they need to improve and grow their business.

If your internal growth rate is low, you must focus on increasing your profit margin and sales growth. You can increase your prices, expand your customer base, and streamline your production process and operations. On the other hand, if your internal growth rate is high, you need to focus on asset turnover and expanding existing processes. You can do this by reducing the amount of money you're spending on assets and increasing sales.

Regardless of your internal growth rate, always remember that internal growth is just as important as external growth. By focusing on both, you can ensure that your company has been healthy and thriving for years.

Benefits of Internal Growth Strategies 

When companies focus on internal growth strategies, it: 

  • Increases the understanding of a company's internal processes. This type of growth is gradual and can be monitored more closely than external growth, which often occurs rapidly. By tracking the internal growth rate, companies can identify potential problems and address them before they become serious.
  • Offers long-term investment opportunities. Companies that reinvest their profits into internal growth can generate more wealth for shareholders over the long term. This is because they can compound their earnings at a higher rate than companies that do not reinvest their profits. A higher dividend payout ratio for shareholders means more people would be willing to invest in the company. 
  • Provides more flexibility with implementation. Companies can tailor their growth plans to their specific needs and resources. This type of growth is also less disruptive to a company's operations than external growth, which often requires significant changes to be made.
  • Creates more independence for companies. They are not reliant on external factors, such as the availability of capital for their growth. This can be a significant advantage in industries where external financing is difficult to obtain.
  • Produces a more consistent work culture. Companies that grow internally typically have employees who are more loyal and dedicated to the company, resulting in higher employee retention. This is because they have been with the company for longer and have a greater understanding of its culture.

Focusing on a sustainable growth rate and using the formulas above to calculate and track your business's internal growth rate will help you in the long run. The more focused your company is on internal growth, the more opportunities there will be to optimize your internal processes and funnel funds back into the business. 

Keep your business's internal growth on track when you use QuickBooks Online to manage your finances. This quality accounting software can track revenue and expenses, send invoices, track inventory, run financial reports, and more. With a comprehensive toolset at your disposal, help ensure the longevity and growth of your company with a free trial today. 

Looking for something else?

Get QuickBooks

Smart features made for your business. We've got you covered.

Firm of the Future

Expert advice and resources for today’s accounting professionals.

QuickBooks Support

Get help with QuickBooks. Find articles, video tutorials, and more.