In: Accounting
S.No | Particulars |
1 | The solvency ratio is used to measure an Organisation’s ability to meet its debt obligations. The solvency ratio indicates whether a Organisation’s cash flow is sufficient to meet its short-and long-term liabilities. |
2 | The solvency ratio is calculated by dividing a organisation's after-tax net operating income by its total debt obligations. The net after-tax income is derived by adding non-cash expenses, such as depreciation and amortization, back to net income. these figures come from the organisation's income statement. Short-term and long-term liabilities are found on the organisation's balance sheet. |
3 |
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. A organisation’s solvency ratio should, therefore, be compared with its competitors in the same industry rather than viewed in isolation. |
Example :-
Particulars | Co. A | Co. B |
Net Income | $5,000 | $5,000 |
Depreciation | $3,500 | $3,500 |
Net Income + Depreciation (A) | $8,500 | $8,500 |
Short-Term Debt | $14,000 | $20,000 |
Long-Term Debt | $14,500 | $25,000 |
ST Debt + LT Debt (B) | $28,500 | $45,000 |
Solvency Ratio = (A)/(B) | 29.82% | 18.89% |
Comment :- Co. A has Better Solvency Ratio Than Co. B.