What is solvency ratio?
Definition of solvency ratio
The solvency ratio measures a company’s ability to pay its debts. This is similar to the liquidity ratio, but it indicates whether cash flow is sufficient to meet long-term debt, rather than short-term.
How to calculate the solvency ratio
The solvency ratio is:
(Net after-tax income + non-cash expenses) / (short-term liabilities + long-term liabilities)
The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations. Solvency ratios vary from industry to industry, but a ratio higher than 20% is generally considered to be financially healthy.
The solvency ratio is commonly used by prospective lenders when evaluating a business.
Got questions? Ask Emily!
FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.
