Solvency

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DEFINITION of 'Solvency'

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.

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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 you calculate the quick ratio?

    There are a few different ways to calculate the quick ratio; each method involves pulling numbers from the financial statements. ... Read Full Answer >>
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    Solvency ratios gauge a company's financial health and its ability to meet long-term obligations. Use solvency ratios to ... Read Full Answer >>
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    An average collection period shows the average number of days necessary to convert business receivables into cash. The degree ... Read Full Answer >>
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