Solvency Ratios

Solvency ratios are the methods used to find out the firm’s ability to meet its long-term requirement obligations and thus remain solvent and avoid insolvency or bankruptcy.  The formula for calculating the solvency ratio are as follows

Solvency ratio is equal to total assets divided by total liabilities.

Solvency ratio is equal to net worth or total equity or total capital divided by total liabilities.

These solvency ratios generally help to know whether the business organization owns more than it owes. When there is higher ratio then there are more solvent the business organization.  Another ratio that could tell how much a business organization relies on debt to finance its assets is as follows:

Debt ratio is equal to total debt divided by total assets.

Usually, both the long-term and short-term assets and debts are utilized in finding out this ratio. In general, the lower the business organization’s reliance on debt to finance its assets, the business organization will have less problems or it is less risky.  The debt to equity ratio is the measure of the business organization or firm’s leverage -how much financing the business has in the form of debt when compared with how much cash it has invested in the business.

Debt-equity Ratio is equal to total liabilities divided by total owner’s equity or Debt Equity Ratio is equal to long-term liabilities divided by total owner’s equity.

In evaluating solvency, it is very important to consider the breakdown of the firm’s liabilities as well. Not all the liabilities are debt in the form of notes payable or bank loans. For instance, there are also wages and salaries payable, accounts payable to the vendors, accrued liabilities, tax payables etc.

Questionnaire:

• What is solvency ratio and mention the formula to find out solvency ratio?
• What are the uses of solvency ratios?