Definition of Solvency Ratios
Looking for Solvency Ratios Assignment help? You are at correct place. Solvency Ratios are calculated to assess the ability of the business to meet its long term liabilities as and when they become due. The Solvency Ratio quantifies the size of the Corporate after tax income, not counting non-cash depreciation expenses as calculated to the total debt obligations of the firm.
These ratios reveal as to how much amount in a business has been invested by proprietors and how much amount has been raised from outside sources. The lower a company’s solvency ratio, the greater the probability that it will default on its debt obligations. Solvency Ratios, with regard to an Insurance Company, means the size of its capital relative to the premium written, and measures the risk an insurer faces of claims it cannot cover.
Solvency Ratio discloses the business ability to meet the interest costs regularly and long term debt at maturity. This ratio is one of the metrics which is used to determine whether a company can stay solvent.
Types of Solvency Ratios
Solvency Ratio includes
Debt to Equity Ratio
Total Debt to Total Assets
Interest Coverage Ratio
Interpretation of Solvency Ratio
The term Solvency Ratio is a comprehensive measure of solvency as it measures cash flow rather than Net Income by including Depreciation to assess a company’s capacity to stay solvent. It measures Cash Flow Capacity in relation to all liabilities rather than only debt. Apart from Debt and Borrowings, Other liabilities include Short-term borrowings such as Accounts Payable and long term such as Capital Lease and pension plan obligations.
Measuring cash flow rather than Net Income is a better determinant of solvency, especially for Companies that incur large amount of depreciation for their assets but have low level of actual profitability. Similarly, assessing a company’s ability to meet all its obligations rather than debt alone provides a more accurate picture of solvency.
A company’s solvency ratio should also be compared with its competitors in the same industry rather than viewed as isolation. For Example: Companies having high debts such as Utilities and Pipelines based industry have lower solvency ratios than sectors such as technology.
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