What is solvency and how do you calculate it?

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Sanne de Vries July 9, 2024
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Solvency represents the ratio between assets or equity and liabilities or debt. The result of calculating solvency shows the extent to which a company depends on others and the extent to which long-term financial obligations can be met.

Why is solvency important?

Good solvency is important for growing a company in a healthy way. If a company has sufficient equity, the risk for a bank in financing is limited. This makes it easier to obtain a business loan for investments, for example. Good solvency also ensures that you have more control over your company’s financial situation.

How do I calculate my solvency?

There is a formula available to calculate a company’s solvency:

(equity / total assets) x 100% = solvency ratio

Example of solvency calculation:

(€ 200,000 / € 400,000) x 100% = 50%

The above calculation shows that the solvency ratio is 50%. This means that every euro on the balance sheet consists of half equity. However, it is possible for a lender to make adjustments to the calculation, so the solvency considered may be lower. Credit providers believe that the solvency ratio should be between 25% and 40%.

How do I improve my solvency?

A company’s solvency can be improved in various ways, such as by reducing debts or building more equity. Good accounts receivable management contributes to this. The faster money comes in, the faster the debt can decrease. Building more equity is possible by increasing profits and implementing cost savings.

Reducing working capital also has a positive impact on solvency. This applies not only to accounts receivable management to get outstanding invoices paid quickly but also by maintaining a smaller inventory. Your total assets decrease as inventory decreases, which lowers the total assets. Solvency improves when total assets decrease and equity remains at least the same. Want to gain more insight into outstanding invoices and improve your accounts receivable management? Start now by using Payt accounts receivable software.

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By Sanne de Vries

Sanne is a business consultant at Payt. She helps companies optimise their financial flows with attention to detail and a deep understanding of business processes.

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