Definition: Solvency is the ability of a corporation to meet its LONG-term financial obligations. Solvency logically compliments liquidity, which is the ability of a corporation to meet its SHORT-term obligations.
To analyze solvency, financial ratios can be used such as:
- Debt to Equity Ratio (divides a company's debt by its equity, showing the relative amount of debt a company has taken on; a low result - below about 0.30 - indicates greater solvency)
- Interest Coverage Ratio (divides operating income by debt interest payments, showing its ability to pay interest on its debt; a higher result means a greater solvency).
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