Solvency Ratio

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Meaning and definition of solvency ratio

Solvency ratio is one of the various ratios used to measure the ability of a company to meet its long term debts. Moreover, the solvency ratio quantifies the size of a company’s after tax income, not counting non-cash depreciation expenses, as contrasted to the total debt obligations of the firm. Also, it provides an assessment of the likelihood of a company to continue congregating its debt obligations.


The formula used for computing the solvency ratio is:

Solvency ratio = (After Tax Net Profit + Depreciation) / Total liabilities

As stated by Investopedia, acceptable solvency ratios vary from industry to industry. However, as a general rule of thumb, a solvency ratio higher than 20% is considered to be financially sound. Generally, a lower solvency ratio of a company reflects a higher probability of the company being on default with its debt obligations.

Different forms of solvency ratios

Generally, there are six key financial ratios used to measure the solvency of a company. These include:

  • Current ratio

Computed as Current Assets ÷ Current liabilities, this ratio helps in comparing current assets to current liabilities and is commonly used as a quantification of short-term solvency.

  • Quick ratio

Also known as ‘liquid ratio’ and computed as Cash + Accounts Receivable ÷ Current liabilities, considers only the liquid forms of current assets thus revealing the company’s reliability on inventory and other current assets to settle short-term debts.

  • Current debts to inventory ratio

Computed as Current liabilities ÷ Inventory, this ratio reveals the reliability of a company on available inventory for the repayment of debts

  • Current debts to net worth ratio

Computed as Current liabilities ÷ Net worth, this ratio indicates the amount due to creditors within a year’s time as a percentage of the shareholders investment

  • Total liabilities to net worth ratio

Computed as Total Liabilities ÷ Net Worth¸ this ratio reveals the relation between the total debts and the owners’ equity of a company. A higher ratio indicates less protection for business’ creditors.

Computed as Fixed Assets ÷ Net Worth, represents the percentage of assets centered in fixed assets I comparison to total equity.  

Quote Guest, 30 March, 2016
How to compute the solvency ratio for a society and how to calculate net profit after tax and what is total liabilities whether inclusive of owner equity or excluding
Quote Guest, 17 August, 2016
had the same conecer than Guest bove. Should Equity be substracted of total liabilities
Quote Guest, 8 December, 2016
These are all liquidity ratios..... Anything "current" is liquidity. Solvency has to do with the long term, so the TOTAL assets and the TOTAL liabilities....

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