Solvency Ratio

Solvency Ratio is a financial metric used to measure an organization’s ability to meet its long-term debts and financial obligations. It indicates the company’s financial health by comparing its total Assets to its total liabilities. A higher solvency ratio suggests a greater ability to cover liabilities, while a lower ratio may indicate financial distress.

Formula: Solvency Ratio = Total Assets / Total Liabilities

Examples:

• Example 1: A company has total Assets of $500,000 and total liabilities of $300,000. The solvency ratio would be calculated as follows:
  Solvency Ratio = $500,000 / $300,000 = 1.67. This indicates the company has $1.67 in Assets for every dollar of Liability.
• Example 2: Another company has total Assets of $200,000 and total liabilities of $250,000. The solvency ratio would be:
  Solvency Ratio = $200,000 / $250,000 = 0.80. This suggests the company may struggle to meet its long-term obligations.

Cases:

• Case A: A firm with a solvency ratio above 1.5 is generally considered financially stable and capable of meeting its long-term obligations.
• Case B: A company with a solvency ratio below 1 indicates potential risk, as it may not have enough Assets to cover its liabilities.