Question

Define the following and provide examples of Financial ratio outcomes which would be positive indicators of a company’s: 1) Solvency 2) Liquidity

Answer 1

1) Solvency

Acceptable solvency ratios vary from industry to industry, but as a general rule of thumb, a solvency ratio of greater than 20% is considered financially healthy. The lower a company's solvency ratio, the greater the probability that the company will default on its debt obligations.

As a general rule of thumb, a solvency ratio higher than 20% is considered to be financially sound; however, solvency ratios vary from industry to industry.

3 types of solvency ratios;

• Debt-to-equity ratios. This ratio is a measure of total debt, compared to shareholder equity. ...
• Total-debt-to-total-asset ratios. This refers to the ratio of long-term and short-term liabilities, compared to total holdings. ...
• Interest-coverage ratios.

Solvency and liquidity are both equally important for a company's financial health. ... Liquidity refers to both an enterprise's ability to pay short-term obligations and a company's capability to sell assets quickly to raise cash. Solvency refers to a company's ability to meet long-term obligations.

Examples of solvency ratios are: Current ratio. This is current assets divided by current liabilities, and indicates the ability to pay for current liabilities with the proceeds from the liquidation of current assets. ... Debt to equity ratio

2) liquidity

In accounting, the liquidity ratio expresses a company's ability to repay short-term creditors out of its total cash. It is the result of dividing the total cash by short-term borrowings. It shows the number of times short-term liabilities are covered by cash. If the value is greater than 1.00, it means fully covered.

Formula: Quick ratio = (marketable securities + available cash and/or equivalent of cash + accounts receivable) / current liabilities. Quick ratio = (current assets – inventory) / current liabilities.

There are three common types of liquidity ratio: the current ratio, the quick ratio and the operating cash flow ratio. The current ratio is used to determine an organisation or individual's ability to pay their short and long-term debts. It compares their total assets (both liquid and fixed) to their total debt.

The current ratio (also known as working capital ratio) measures the liquidity of a company and is calculated by dividing its current assets by its current liabilities. The term current refers to short-term assets or liabilities that are consumed (assets) and paid off (liabilities) is less than one year.

Liquidity ratios are important to investors and creditors to determine if a company can cover their short-term obligations, and to what degree. ... The higher the ratio is, the more likely a company is able to pay its short-term bills.