Economic Spread

What Is an Economic Spread?

An economic spread is a performance metric that is equivalent to the difference between a company's weighted average cost of capital (WACC) and its return on invested capital (ROIC).

The term can be utilized to measure the difference between the real rate of return on an investment and the rate of inflation in the economy.

Grasping Economic Spreads

Basically, an economic spread is a measure of a company's ability to bring in money on its capital investments. Assuming the cost of capital surpasses the return on invested capital, the company is losing money; how the capital is doing its assets isn't adequately giving to cover the cost of borrowing or utilizing it. This could be down to shortcomings or only a poor investment.

A company with a high economic spread is an indication of proficiency and great overall performance. Going against the norm, a company can have a negative economic spread, which can be an indication of stress on its assets and can frequently mean the assets are obsolete or the company is over-utilized.

A few financial pundits allude to economic spread as market value added in light of the fact that the spread is a representation of a company's value from an operations outlook.

Special Considerations

The term is important for assessing the returns of a pension plan. The value of its invested funds might be expanding at what is by all accounts an acceptable level, however in the event that the invested capital isn't developing at a rate above inflation, the investment is losing its value on a annual basis.

This nominal loss results from the way that the invested capital can not buy as much for the investor in the future as possible right now.

Highlights

• A negative economic spread proposes a company is over-utilized or not utilizing its capital fittingly.
• An economic spread is a performance metric utilized by companies to determine the difference between a company's weighted average cost of capital and its return on invested capital.
• Estimations of economic spreads and the real rate of return must likewise consider inflation.
• A company with a high economic spread is an indication of proficiency and great overall performance.
• Companies ascertain economic spreads to determine how well they are utilizing their capital.