Solvency is a company’s ability to meet it long-term obligations as they become due. An analysis of solvency concentrates on the long-term financial and operating structure of the business.
The degree of long-term debt in the capital structure is also considered. Further, solvency is dependent upon profitability since in the long run a firm will not be able to meet its debts unless it is profitable.
When debt is excessive, additional financing should be obtained primarily from equity sources. Management might also consider lengthening the maturity of the debt and staggering the debt repayment dates.
Some leverage ratios follow.
Debt Ratio. The debt ratio compares total liabilities (total debt) to total assets. It shows the percentage of total funds obtained from creditors.
Creditors would rather see a low debt ratio because there is a greater cushion for creditor losses if the firm goes bankrupt.
Debt ratio = total liabilities/ total assets
For the Ratio Company, in 20X3 the debt ratio is: $135,400/ $220,000 = 0:62
In 20X2, the ratio was 0.63. There was a slight improvement in the ratio over the year as indicated by the lower degree of debt to total assets.
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