Financial Statement Analysis

- Ratio Analysis of Financial Statements (Formula, Types, Excel)
- Ratio Analysis Advantages
- Ratio Analysis
- Liquidity Ratios
- Cash Ratio
- Cash Ratio Formula
- Quick Ratio
- Quick Ratio Formula
- Current Ratio
- Current Ratio Formula
- Acid Test Ratio Formula
- Defensive Interval Ratio
- Working Capital Ratio
- Working Capital Formula
- Net Working Capital Formula
- Changes in Net Working Capital
- Current Ratio vs Quick Ratio
- Bid Ask Spread
- Liquidity vs Solvency
- Liquidity
- Solvency
- Solvency Ratios
- Liquidity Risk
- Altman Z Score

- Turnover Ratios
- Profitability Ratios
- Profitability Ratios Formula
- Profit Margin
- Gross Profit Margin Formula
- Operating Profit Margin Formula
- Operating Income Formula
- Net Profit Margin Formula
- EBIDTA Margin
- OIBDA
- Earnings Per Share
- Basic EPS
- Diluted EPS
- Basic EPS vs Diluted EPS
- Return on Equity (ROE)
- Return on Capital Employed (ROCE)
- Return on Invested Capital (ROIC)
- ROIC vs ROCE
- ROE vs ROA
- CFROI
- Cash on Cash Return
- Return on Total Assets (ROA)
- Return on Average Capital Employed
- Capital employed Employed
- Return on Average Assets (ROAA)
- Return on Average Equity (ROAE)
- Return on Assets Formula
- Return on Equity Formula
- DuPont Formula
- Net Interest Margin Formula
- Earnings Per Share Formula
- Diluted EPS Formula
- Contribution Margin Formula
- Unit Contribution Margin
- Revenue Per Employee Ratio
- Operating Leverage
- EBIT vs EBITDA
- EBITDAR
- Capital Gains Yield
- Tax Equivalent Yield
- LTM Revenue
- Operating Expense Ratio Formula
- Overhead Ratio Formula
- Variable Costing Formula
- Capitalization Rate
- Cap Rate Formula
- Comparative Income Statement
- Capacity Utilization Rate Formula
- Total Expense Ratio Formula

- Efficiency Ratios
- Dividend Ratios
- Debt Ratios
- Debt to Equity Ratio
- Debt Coverage Ratio
- Debt Ratio
- Debt to Income Ratio Formula (DTI)
- Capital Gearing Ratio
- Capitalization Ratio
- Interest Coverage Ratio
- Times Interest Earned Ratio
- Debt Service Coverage Ratio (DSCR)
- Financial Leverage Ratio
- Financial Leverage Formula
- Net Debt Formula
- Leverage Ratios
- Operating Leverage vs Financial Leverage
- Current Yield
- Debt Yield Ratio

## What is Solvency?

Solvency is the ability of the firm to continue its operations for a long period of time. In simple terms, solvency ensures whether a firm is stout enough to pay off long-term debt. The basic difference between liquidity and solvency is all about firm’s ability to pay off the short-term debt (in the case of liquidity) or long-term debt (in the case of solvency).

Here, instead of taking a company’s example, we will try to understand solvency from an individual’s perspective. Taking individual’s perspective will ease off the process and an investor who is investing in company individually would be able to understand when to go for big investment and when to retreat.

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Let’s take an example to illustrate this.

### Solvency Example

Let’s say that Mr. Goddin wants to invest in a company. His friend told him that it’s very good idea to invest into that particular company since the company is doing quite well. But Mr. Goddin isn’t sure that whether he has enough money to get into something.

So he goes to one of his friends who invest into companies. The friend tells him to look at the solvency of his own individual account.

Here’s what Mr. Goddin comes up with –

**Assets –**

**Cash – $50,000****House – $200,000****Car – $15,000****Other Assets – $10,000**

**Liabilities –**

**Educational loan for his first child – $30,000****Mortgage on the house – $100,000****Credit Card Debt – $20,000**

Mr. Goddin now decides to find out how much total assets he owns and how much total liabilities he has to pay off.

**Total Assets –**

**Cash – $50,000****House – $200,000****Car – $15,000****Other Assets – $10,000****Total assets – $275,000**

**Total Liabilities –**

**Educational loan for his first child – $30,000****Mortgage on the house – $100,000****Credit Card Debt – $20,000****Total liabilities – $150,000**

Now Mr. Goddin wants to know his net worth. His investor friend mentions that after liquidating all his assets and liabilities if Mr. Goddin sees that he is still left with a positive net worth, he should go ahead and invest in that particular company his another friend suggested.

If Mr. Goddin finds that his net worth is negative, then it’s better first to pay off all his additional debt.

So Mr. Goddin deducts his total liabilities from his total assets and comes up with the following –

**Net Worth Formula = (Total Assets – Total Liabilities) = ($275,000 – $150,000) = $125,000.**

From the above calculation, Mr. Goddin gets clear about whether he should invest in a new company right now or not. Since his net worth is positive and he would have a healthy amount in his pocket even after paying off the all he owes, he decides to go ahead with the investment.

### Solvency of a Company

Now if you are running a business and you want to invest into a project or buy a chunk of shares of a new start-up, first you need to find out how much net worth your company has. If your company is liquidated immediately, can your company be able to survive for some time at least?

For companies, the approach would be a bit different because, in the case of companies, you need to think through your fixed expenses, your variable expenses every month, your production cost/servicing cost, and so on and so forth.

So as a company owner you need to make sure that you have at least 6 months to 1 year of working capital ready before investing in any new project.

Plus the company can use debt to equity ratio and interest coverage ratio to find out whether the firm is able to pay off its long-term debt or not.

Debt to equity ratio would tell the company that whether its equity is enough to pay off the debt. Or else, the firm can check its income statement and can find out the EBIT and the interest charges for debt payment. And they will get an idea about whether they have enough earnings before interest and taxes to pay off the interest payment for a debt.

However, whether to invest in a project or not is completely a different ball game altogether.

### Video on Solvency

### Recommended Articles

This has been a guide on what is Solvency along with examples of calculating solvency. Here we also discuss solvency from individual as well as from a company point of view. You may also have a look at these articles below to learn more about Corporate Finance –

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