The solvency ratio, what is it

8 avril 2022

The solvency ratio, what is it?
The solvency ratio corresponds to a company's ability to repay its debts.

Let's see together what the characteristics of the solvency ratio are, how to calculate it, and what it is used for.

Characteristics of the solvency ratio
The solvency ratio gives a picture of the financial health of the company. It is expressed as a percentage.

It is useful for business managers to calculate these ratios during the financial development of the business. It can also be requested by banks, which need guarantees before granting a loan.

There are different ratios, which do not specifically concern the financial state of the company, but which measure other indicators, for example: structure ratios, inventory turnover ratio.

The different solvency ratios
There are several solvency ratios, including:

The financial autonomy ratio: this measures a company's dependence on financing external to the company (banks for example). The ideal being not to be too dependent on the banks. It is calculated by dividing the capital by the total amount of the balance sheet.

General liquidity ratio: also called working capital ratio, this general liquidity ratio is calculated by dividing current assets by current liabilities. It measures the company's ability to pay its short-term debts.

The repayment capacity ratio: it calculates the company's ability to repay its debts. This must be below 3. Beyond that, the company does not have sufficient repayment capacity. Just divide net debt by cash flow.

Why calculate the solvency ratio?
The calculation of the solvency ratio can be essential when a company plans to develop, and is therefore looking for financing. It is also an interesting measure for the company, which allows it to compare the evolution of the company over the years. It is also a useful indicator for investors who are interested in the company, and who are thinking of investing.