# Solvency Ratio

**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.

**Formula **

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

**Quick ratio**

Also known as ‘liquid ratio’ and computed as

Cash + Accounts Receivable÷, 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 liabilities

**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÷, this ratio indicates the amount due to creditors within a year’s time as a percentage of the shareholders investmentNet worth

**Total liabilities to net worth ratio**

Computed as

Total Liabilities÷¸ 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.Net Worth

Computed as

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

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