Solvency

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What is 'Solvency'

Solvency is the ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a company also needs liquidity to thrive. Liquidity is a company's ability to meet its short-term obligations. A company that is insolvent must enter bankruptcy; a company that lacks liquidity can also be forced to enter bankruptcy even if it is solvent.

BREAKING DOWN 'Solvency'

Investors can use ratios to analyze a company's solvency. The interest coverage ratio divides operating income by interest expense to show a company's ability to pay the interest on its debt, with a higher result indicating a greater solvency. The debt-to-equity ratio divides a company's debt by its equity to show whether a company has taken on too much debt, with a lower result indicating a greater solvency. Solvency ratios vary by industry, so it's important to understand what constitutes a good ratio for the company in question before drawing conclusions from the ratio calculations.

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RELATED FAQS
  1. How do unfunded capital expenditures and distributions affect the fixed charge coverage ...

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  2. Are solvency ratios more concerned with the short-term or the long-term?

    Learn what solvency is, how to use ratios to determine a company's solvency, and why solvency ratios are concerned with the ... Read Answer >>
  3. What are the differences between solvency ratios and liquidity ratios?

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  4. What can I tell about a company by looking at its solvency ratios?

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  5. How are liquidity ratios different than solvency ratios?

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  6. What is the difference the operating cash flow ratio and solvency ratio?

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