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Understanding Solvency Ratios

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Solvency Ratio FormulaThis presentation is about the ‘solvency ratio formula’ and is written by Russell Bowyer. This subject is one that I’ve had experience within my own company and in helping other entrepreneurs in business.The following headings are discussed: What is the Definition of the Solvency Ratio Formula? Solvency Problems are Stressful for Company Directors. So What is the Solvency Ratio Formula? Includes an example of using

the formula. What is Considered to be a Good Solvency Ratio? 20% is a Guide Only. Other Factors That Affect Company Solvency. There are Additional Solvency Ratios to Keep Track of. Interest Cover Ratio. Liquidity Ratios: Including Current Ratio & Quick Ratio Introducing the 5 Pillars of Solvency and the Solvency Ratio Formula

Info-graphic.

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i. According to Investopedia it is “A key metric to measure an enterprises ability to meet its debt and other obligations.”

ii. I would add to that definition by saying it is also important to meeting debt and other obligations…’as and when they fall due.’

iii. The solvency ratio is a good indicator as to whether a company will have sufficient cash flow.

iv. If a business is unable to meet its liabilities, as and when they fall due, then it’s deemed to be insolvent.

To Read The Full Text – Definition of the Solvency Ratio Formula

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inBusiness Blog - www.in-business.org.uk

i. When a company is going through solvency issues this can be extremely stressful for the directors.

ii. Directors must be aware of fraudulent or insolvent trading at all times.

iii. They must be careful not to take on debt with the knowledge that it’s not going to be paid.

iv. keeping a close eye on the companies solvency ratio is key for management.

v. The art of great management is all about planning.

To Read The Full Text – Solvency Problems are Stressful for Company Directors

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So What is the Solvency Ratio Formula?

Solvency Ratio = (Post Tax Profits + Depreciation & Amortisation)/ Total liabilities*

* Total liabilities = Both short-term liabilities (i.e. falling due within one year) and long-term liabilities (i.e. falling due after more than one year)

To Read The Full Text – What is the Solvency Ratio Formula

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In the example balance sheet the solvency ratio for XYZ Company is 30%. Whereas in 2017 this has dropped to 11.9%. These two solvency ratios are calculated, as follows:

2016 year: £118,500/£395,000 = 30%2017 year: £26,500/£223,000 = 11.9%

Solvency Ratio = (Post Tax Profits + Depreciation & Amortisation)/ Total liabilities*

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i. A company which has a solvency ratio great than 20% is considered to be financially sound.

ii. Whilst a metric like the solvency ratio formula is good as a guide, there are many other factors to consider.

iii. Where the business is inefficient at the collection of its debtors, the solvency ratio may look good, when in fact cash flow is being badly affected by slow paying customers.

iv. Solvency ratio formula is based on profits, bit we know profit is not always cash in the bank.

v. Management shouldn’t use the solvency ratio formula in isolation

To Read The Full Text – What is Considered to be a Good Solvency Ratio

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Interest Cover Ratioi. The interest cover ratio is a company’s operating income (i.e. profits

before interest and tax; EBIT) divided by the interest expense.ii. An acceptable interest cover ratio is 2 or more.iii. Banks prefer a coverage of 3 or more.iv. If cover drops to 1 or below, this indicates a company which cannot meet

its interest obligations as they fall due.v. Bank borrowing usually comes with interest cover terms.vi. Loan agreements usually include covenants. One of which is usually

profitability and interest cover.

To Read The Full Text – Interest Cover Ratio

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i. Current Ratio – This is the ratio between current assets and current liabilities - The formula to work this out is: Current Ratio = Current Assets/Current Liabilities.

ii. Quick Ratio – this is similar to the current ratio, but includes current assets that are easily liquid assets - The formula to work out the quick ratio = (Current Assets –Stock)/Current Liabilities

To Read The Full Text – Liquidity Ratios

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i. Solvency Ratio Formula - Keep your solvency ratio above 20%ii. Cash Flow - Good cash flow is the live-blood of a thriving and healthy

business.iii. Current Assets - Convert your current assets into cash or cash equivalent

as soon as possible.iv. Liabilities - Keep a tight control over your liabilities.v. Profits - High profits combine with converting them into cash equals a

healthy thriving business.

To Read The Full Text – Introducing the 5 Pillars of Solvency

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inBusiness Blog

To Read Russell’s Business Blog With Topics

Intrapreneurship DefinitionAdvantages and Disadvantages of Offshoring

About Russell Bowyer & How Whilst fighting For His Life From Cancer, he Began to Write Again

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