CandleFocus Glossary Editor
Solvency Ratio is one of the most important financial metrics for businesses of any size – large or small, mature or startup – to understand and manage. It is used to measure a company’s ability to meet its long term debts and obligations, without liquidating all of its assets. It is a key metric used by potential lenders and investors to evaluate a company’s creditworthiness and a primary measure of financial strength.
Usually Solvency Ratios measure the proportion of debt and other liabilities to equity and assets. While liquidity ratios measure a company’s ability to meet its planned debt payments, solvency ratios measure a company’s ability to pay off its long term debt obligations.
The most common solvency ratios used are Debt to Assets Ratio, Interest Coverage Ratio, Equity Ratio and Debt to Equity (D/E) Ratio.
Debt to Assets Ratio compares a company’s total liabilities to its total assets. Lenders and investors look for a low debt to asset ratio, typically below 0.50, as an indication that the company is solvent and can cover its total liabilities with the assets it owns or has access to.
Interest Coverage Ratio measures a company's ability to pay off its interest expense on its outstanding debt, typically taking its EBIT (Earnings before Interest and Tax) as denominator.
The Equity Ratio measures the portion of equity in a company’s capital structure by calculating a company’s total equity divided by its total assets.
The Debt to Equity Ratio measures the portion of debt in a company’s capital structure, essentially how much of a company’s assets are being financed by debt. This ratio is calculated by dividing a company’s total debt by its total equity.
Solvency Ratios are valuable indicators of financial strength when evaluated in combination. They are particularly effective when used to review and compare a company’s performance from period to period and when compared to similar companies in the same industry.
Businesses should regularly track their solvency ratios measure the prospective financial health of the business. This can provide owners and directors with useful information when considering the appropriateness of their debt levels, income sources and potential investments.
Solvency Ratios can become less meaningful when interpreted in isolation and without their usual context. Comparing several ratios over time and against other companies in the same industry will give a more complete picture of a company’s financial health and help identify issues within the business before they become too large.
Usually Solvency Ratios measure the proportion of debt and other liabilities to equity and assets. While liquidity ratios measure a company’s ability to meet its planned debt payments, solvency ratios measure a company’s ability to pay off its long term debt obligations.
The most common solvency ratios used are Debt to Assets Ratio, Interest Coverage Ratio, Equity Ratio and Debt to Equity (D/E) Ratio.
Debt to Assets Ratio compares a company’s total liabilities to its total assets. Lenders and investors look for a low debt to asset ratio, typically below 0.50, as an indication that the company is solvent and can cover its total liabilities with the assets it owns or has access to.
Interest Coverage Ratio measures a company's ability to pay off its interest expense on its outstanding debt, typically taking its EBIT (Earnings before Interest and Tax) as denominator.
The Equity Ratio measures the portion of equity in a company’s capital structure by calculating a company’s total equity divided by its total assets.
The Debt to Equity Ratio measures the portion of debt in a company’s capital structure, essentially how much of a company’s assets are being financed by debt. This ratio is calculated by dividing a company’s total debt by its total equity.
Solvency Ratios are valuable indicators of financial strength when evaluated in combination. They are particularly effective when used to review and compare a company’s performance from period to period and when compared to similar companies in the same industry.
Businesses should regularly track their solvency ratios measure the prospective financial health of the business. This can provide owners and directors with useful information when considering the appropriateness of their debt levels, income sources and potential investments.
Solvency Ratios can become less meaningful when interpreted in isolation and without their usual context. Comparing several ratios over time and against other companies in the same industry will give a more complete picture of a company’s financial health and help identify issues within the business before they become too large.