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Solvency Ratio

Solvency Ratio Assignment / Homework Help
Solvency ratio is a ratio that is used to measure the ability of a company to meet ist long term commitments or obligations. It measures a company's ability to service debt and is expressed as a percentage. It is computed as:

   Net profit after taxes + Depreciation   
Long term liabilities + Short term liabilities

Higher the ratio, the better indication that the company is in a sound financial health and would be able to meet its debt obligations. Higher the ratio, higher is the degree of comfort enjoyed by the creditors of the company. A low ratio on the other hand may indicate the likelyhood of default on debt commitments by the company. This ratio is also closely watched by potential lenders to assess the risk involved in lending and gauge the ability of the company to repay the amount. The ratio however varies from one industry to another and must be compared with the norms for the industry to assess if the company has a decent solvency ratio.

Example:

A company earned a net profit of $452,435 during the year 2009. The depreciation expense for the year amounted to $38,754. The company had short term liabilities of $1,234,964 and long term liabilities of $2,765,432. Calculate the company's solvency ratio.


    $452,435 + $38,754    
$1,234,964 + $2,765,432

=> 12.28%


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