Solvency of an enterprise is the ability of a specific entity to fully repay loan debt on time. It is a key sign of the normal and sustainable economic situation of any organization.
The solvency of the company will consist of the following factors.
Firstly, an enterprise has assets (that is, property and cash) that are sufficient to pay off all liabilities that an organization has.
Secondly, the degree of liquidity of those assets that the company has should be sufficient to sell them if necessary, transferring them to money and in such an amount that is sufficient to pay off the obligations.
The enterprise management is recommended to use methods of analysis of financial condition, one of which is solvency ratio. Let us dwell on them in more detail.
The first solvency ratio should be aimed at examining whether a company has equity. If the company does not have one, then the organization will not be able to pay its obligations. Such a company is solvent only for the short term, paying off existing debts. But sooner or later, she is likely to expect bankruptcy.
The second, more stringent solvency ratio of the company is an indicator of the availability of own funds, the norm of which is approved by the Federal Bankruptcy Administration. It is calculated by a special formula. The value of non-current assets is deducted from the indicator of equity . The resulting number must be divided by the number of current assets. This value (favorable) should be at least 0.1.
But the company’s presence of positive net assets does not always mean that it has good solvency. The fact is that an analysis of the second factor mentioned above is necessary - the liquidity of assets.
Situations may be unexpected. So, there is often a mismatch between the available liquidity of all assets and the upcoming maturities of loan obligations. For example, a company, on the one hand, has a large share of non-current assets that are difficult to realize because they are low liquid. But, on the other hand, it has a large share of short-term obligations. In such a case, sooner or later, the moment may come when the enterprise will not have the funds to pay off current liabilities. In this case, it will be necessary to use a special solvency ratio. This is a measure of liquidity (fast, current and, of course, absolute).
These coefficients will be calculated on a single basis. The ratio of current assets of different liquidity to existing liabilities is taken into account. But the solvency and current liquidity ratio will be calculated taking into account existing current assets, and quick liquidity - taking into account liquid current assets. The calculation of the absolute indicator is based on a system of highly liquid assets (cash and short-term financial assets).
The head of the enterprise needs to keep in mind that if liquidity ratios fit into the officially adopted standard, then the company will be considered reliable and prosperous. Otherwise, a mandatory calculation of the solvency recovery indicator is required.
As a result, there should be a coefficient of total solvency, which is able to show the ability of an enterprise to cover all its obligations (long-term and short-term) with available assets.