What are Solvency Ratios?

Solvency ratios come in several flavors, but they all seek to shed light on a company’s ability to pay its long-term debt obligations.

There are several types of what is known as solvency ratios. Some examples of solvency ratios include debt-to-equity, debt-to-assets, interest-coverage ratio, the quick ratio, the current ratio, and so forth.

These are meant to be metrics for a company’s ability to meet its debt obligations through various market conditions. The quick ratio, for instance, can reveal whether the current-year liabilities (payables) of a company are covered by the current year cash and receivables, or whether the company will depend on other sources such as inventory liquidation to meet this need.

There is also a ratio that is sometimes called the basic solvency ratio, which is net after tax income with depreciation added back in, divided by all liabilities (current and long-term). This basically gives us an idea of how long it would take the company to pay off their liabilities if they had to.

In the banking world, the Basel III international capital reserve regulations define the solvency ratio as the comparison between regulatory capital and risk-weighted assets. If this ratio falls below 7%, starting in 2019, the bank will most likely receive a visit from a regulator.

These regulations are thought to be in the best interest of the world economy, and they attempt to prevent another 2008 meltdown from happening.