Updated on March 9, 2023
Solvency means a company’s ability and capacity to meet its long-term debt obligations. Solvency ratio forms an integral part of financial analysis of a business. It helps in measuring the cash flows and to arrive at a decision with respect to the company’s ability to manage its debt obligations. Solvency ratios are also known as ‘Leverage Ratios’. A company with a low solvency ratio is considered at risk of being unable to fulfil its debt obligations and might default in its repayments.
Which are the key Solvency ratios?
Solvency ratio is key to businesses and is calculated from the balance sheet and income statement. Key Solvency ratios are :
1. Debt to equity ratio
2. Equity ratio
3. Debt ratio
4. Interest coverage ratio
How to use Solvency ratios?
The primary use of Solvency ratio is :
a) These are used by lenders for ascertaining the business solvency or financial strength.
b) Companies with a higher solvency ratio are considered to be good in meeting debt obligations while those with a lower solvency ratio are risky for creditors.
c) Solvency ratios are different across industries, but a solvency ratio of 0.5 is considered as a good measure.