Solvency Ratio

Loading the player...

What is the 'Solvency Ratio'

A key metric used to measure an enterprise’s ability to meet its debt and other obligations. The solvency ratio indicates whether a company’s cash flow is sufficient to meet its short-term and long-term liabilities. The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations.

The measure is usually calculated as follows:

BREAKING DOWN 'Solvency Ratio'

Solvency ratio, with regard to an insurance company, means the size of its capital relative to the premiums written, and measures the risk an insurer faces of claims it cannot cover.

The solvency ratio is only one of the metrics used to determine whether a company can stay solvent. Other solvency ratios include debt to equity, total debt to total assets, and interest coverage ratios.

However, the solvency ratio is a comprehensive measure of solvency, as it measures cash flow – rather than net income – by including depreciation to assess a company’s capacity to stay afloat. It measures this cash flow capacity in relation to all liabilities, rather than only debt. Apart from debt and borrowings, other liabilities include short-term ones such as accounts payable and long-term ones such as capital lease and pension plan obligations.

Measuring cash flow rather than net income is a better determinant of solvency, especially for companies that incur large amounts of depreciation for their assets but have low levels of actual profitability. Similarly, assessing a company’s ability to meet all its obligations – rather than debt alone – provides a more accurate picture of solvency. A company may have a low debt amount, but if its cash management practices are poor and accounts payable is surging as a result, its solvency position may not be as solid as would be indicated by measures that include only debt.

A company’s solvency ratio should also be compared with its competitors in the same industry rather than viewed in isolation. For example, companies in debt-heavy industries like utilities and pipelines may have lower solvency ratios than those in sectors such as technology. To make an apples-to-apples comparison, the solvency ratio should be compared for all utility companies, for example, to get a true picture of relative solvency.

RELATED TERMS
  1. Solvency

    The ability of a company to meet its long-term financial obligations. ...
  2. Solvency Capital Requirement

    The amount of funds that insurance and reinsurance undertakings ...
  3. Free Asset Ratio - FAR

    A metric used to determine whether an insurance company has sufficient ...
  4. Keepwell Agreement

    A contract between a parent company and its subsidiary to maintain ...
  5. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  6. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
Related Articles
  1. Investing

    Solvency Ratio

    The Solvency Ratio is one of many ratios used to measure a company's ability to pay its debts. Generally, the higher the ratio the better.
  2. Investing

    Financial Analysis: Solvency Vs. Liquidity Ratios

    Solvency and liquidity are equally important for a company's financial health. A number of financial ratios are used to measure a company’s liquidity and solvency, and an investor should use ...
  3. Markets

    Analyze Investments Quickly With Ratios

    There are four categories of financial ratios: profitability, liquidity, solvency and valuation.
  4. Investing

    What Is the Best Measure of a Company's Financial Health?

    Discover the single best financial metric that investors can use for determining the financial health and long-term sustainability of a company.
  5. Markets

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  6. Investing

    Analyzing Oracle's Debt Ratios in 2016 (ORCL, SAP)

    Learn how the debt ratio, debt-to-equity ratio and debt-to-capital ratio are used to evaluate Oracle Corp.'s liabilities, equity and assets.
  7. Investing

    Total Debt to Total Assets

    Total Debt to total assets, also called the debt ratio, is an accounting measurement that shows how much of a company’s assets are funded by borrowing. In business, borrowing is also called leverage.
  8. Markets

    Using The Current Ratio

    Find out more on how this liquidity ratio is used to measure a company's ability to pay short-term obligations.
  9. Investing

    Debt Ratios: Cash Flow To Debt Ratio

    By Richard Loth (Contact | Biography)This coverage ratio compares a company's operating cash flow to its total debt, which, for purposes of this ratio, is defined as the sum of short-term borrowings, ...
  10. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
RELATED FAQS
  1. How do unfunded capital expenditures and distributions affect the fixed charge coverage ...

    Learn about the most common solvency ratio and what it measures. Understand two other liquidity ratios that are commonly ... Read Answer >>
  2. What can I tell about a company by looking at its solvency ratios?

    Learn about solvency ratios, how to calculate two solvency ratios and what solvency ratios indicate about a company when ... Read Answer >>
  3. What is the difference the operating cash flow ratio and solvency ratio?

    Learn about the operating cash flow ratio and the solvency ratio, what they measure, and the difference between the operating ... Read Answer >>
  4. How are liquidity ratios different than solvency ratios?

    Learn what liquidity and solvency are, what liquidity and solvency ratios calculate, and the main difference between the ... Read Answer >>
  5. What measures should a company take if its total debt to total assets ratio is too ...

    Learn how the total debt to total assets ratio is analyzed by investors and lenders, and how a high ratio can be remedied ... Read Answer >>
  6. Is the bottom line the best representation of a company's financial strength?

    Learn about the important factors determining a company's financial strength. Find out what net profit can tell you about ... Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center