Solvency Ratio

Solvency Ratio

A measure of a company's ability to service debts, expressed as a percentage. It is calculating by adding the company's post-tax net profit and depreciation, and dividing the sum by the quantity of long-term and short-term liabilities; the resulting amount is expressed as a percentage. A high solvency ratio indicates a healthy company, while a low ratio indicates the opposite. A low solvency ratio further indicates likelihood of default. Different industries have different standards as to what qualifies as an acceptable solvency ratio, but, in general, a ratio of 20% or higher is considered healthy. Potential lenders may take the solvency ratio into account when considering making further loans.

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Solvency Ratio

What Does Solvency Ratio Mean?

One of many ratios used to measure a company's ability to meet its long-term obligations. The solvency ratio measures the size of a company's after-tax income, excluding noncash depreciation expenses, compared with the firm's total debt obligations. It provides a measurement of how likely it is a company can continue to meet its debt obligations. The measure is calculated as shown here:

Investopedia explains Solvency Ratio

Solvency ratios can vary from one industry to the next, but as a rule of thumb, a solvency ratio greater than 20% is considered financially healthy. Conversely, the lower a company's solvency ratio is, the greater is the likelihood that the company will default on its debt obligations.

Related Terms:
• Asset Turnover
• Balance Sheet
• Bankruptcy
• Fundamental Analysis
• Liquidity Ratios