Solvency
Definition
Solvency is the ability of an individual or business to meet long-term financial obligations and continue operations without risk of bankruptcy.
Explanation
Solvency is measured by comparing assets to liabilities. A solvent entity has total assets greater than total liabilities. For businesses, solvency ratios include debt-to-equity and interest coverage ratios. Insolvency occurs when liabilities exceed assets, potentially leading to bankruptcy.
Maintaining solvency requires managing debt levels, generating sufficient income, and building asset values. Solvency differs from liquidity: a solvent company might still have short-term cash flow problems.
Example
A business with $500,000 in assets and $200,000 in liabilities is solvent with a 2.5:1 asset-to-liability ratio and low bankruptcy risk.