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

    Solvency ratios gauge a company's financial health and its ability to meet long-term obligations. Use solvency ratios to ... Read Full Answer >>
  3. Why is Average Collection Period important to a company?

    An average collection period shows the average number of days necessary to convert business receivables into cash. The degree ... Read Full Answer >>
  4. What does financial accounting focus on?

    The focus of financial accounting is on summarizing and reporting a business's financial position to entities outside the ... Read Full Answer >>
  5. What are the differences between chapter 7 and chapter 11 bankruptcy?

    Chapter 7 bankruptcy is sometimes also called liquidation bankruptcy. Firms experiencing this form of bankruptcy are past ... Read Full Answer >>
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    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>

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