Equity spread definition
/What is Equity Spread?
Equity spread measures the value created by the equity base of a business. It is the difference between the return on equity for a period and the cost of equity, which is then multiplied by the beginning equity balance. A well-managed company that occupies a secure market niche should be able to maintain a strongly positive equity spread.
How to Improve Equity Spread
The equity spread is improved by increasing the return on equity, which can be done in the following ways:
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Increase the profit percentage on sales , so that more profits are being generated for each dollar of sales created.
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Shift to a higher proportion of debt funding, so that the equity base of the business is reduced. However, this means that the business will be more leveraged, and so will have a higher obligation to pay interest to lenders.
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Increase the rate of turnover, thereby reducing the need to invest in more assets. This can be done by shrinking the amount of accounts receivable and/or inventory outstanding.
It is also possible to improve the equity spread by reducing the cost of equity, such as by retiring preferred stock that has a high fixed dividend rate.