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:

Increase the profit percentage on sales, so that more profits are being generated for each dollar of sales created.
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.
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.