The solvency of a business

By Peter Nunes d’Agrella

The solvency of the company indicates that the company can fulfill its obligations on the longer term. By calculating the ratios between total assets and total liabilities and between the proprietary and foreign capital a clear picture can be formed of the relative proportions.

Remember the following facts:

a) the company is sound, if

  • liquidity and solvency are within the requirements
  • the working capital is not too high
  • one may assume that this position will be maintained on the short and longer term

b) the company enters the danger zone, if

  • above mentioned requirements are met, but the developments are not entirely hopeful

c) the company is in danger, if

  • liquidity is not or just barely present

Direct actions must be taken and can include:

  • sale of fixed assets
  • no credit to customers
  • reduction of stock
  • buying off the creditors
  • and the design of a survival plan

If your company is currently in such a position ask for assistance from your accountant or a business advisor.

Solvency formulas

Total assets / total liabilities =_____ (should be at least 1.5x)

(Total liabilities / total assets) x 100% =_____% (should be at least 67%)

Proprietary capital / foreign capital =_____ (should be at least 1:2)

(Proprietary capital / total assets) x 100% =_____% (should be at least 33%)

Debt to Worth ratio = total liabilities / net worth = _____

Net Worth = total assets – total liabilities = _____

Working capital = total current assets – total current liabilities = _____

Net sales to Working capital ratio = net sales / net working capital = _____

An excerpt from PlanMagic Business