2023-06-21 21:41:55
The economic solvency It is crucial when evaluating the financial situation of companies and people. Determines the ability of entities to meet their payment commitments.
Being a key indicator, we decided to talk about it in depth. In the next post, we will tell you what is economic solvencywhy it is so important and how you can calculate it – both for companies and individuals.
What is economic solvency?
Economic solvency is a concept used in finance to define the ability of an entity, whether legal or personal, to meet its obligations financial in the short and long term.
It is used both in the world of corporate finance to measure the financial health of companies, and in personal finance to know the economic status of an individual when acquiring a loan.
Why financial solvency is important
Calculating the economic solvency of an entity is important for many reasons. In the first instance, it allows us to know if a company, person or family can respond to its acquired financial obligations – this includes payment to suppliers, commitments with creditors or workers -.
For example, you can know if a company will be able to pay its debts instantaneous or future, or instead, you could be facing serious financial problems, and even bankruptcy.
Remember that creditors can claim and seize assets. In the case of people, if they do not pay their debts, they can enter the annoying list of defaulters.
Those who use financial solvency the most to make informed decisions are lenders. In this way they know if a credit or loan applicant is able to repay the debts, or is facing serious financial problems.
A good financial solvency improves the chances of obtaining good financing. The conditions are more favorable, such as a low interest rate or comfortable repayment terms.
Finally, we can add that the economic solvency helps maintain the confidence of investors, creditors and suppliers in business, as it shows that the company, or individual, honors its financial commitments and properly manages its finances. A great complement to protection against defaulters.
How financial solvency is calculated
In essence, knowing if an entity is solvent or insolvent is simple. Simply, it is necessary to know if the assets of a company or family are superior to its liabilities.
But, that’s just theory. To know the true solvency, and obtain a economic solvency certificateyou must use formulas countable from data of a balance of situation.
This is where the ieconomic solvency indicators. Formulas to evaluate the degree of response and indebtedness of companies and individuals.
There are 4 that are especially useful. These are:
debt ratio. It is an indicator that shows the proportion of debt in relation to total assets. It allows evaluating the level of indebtedness of a company or person and its ability to meet said obligations. It is calculated by dividing the total debts acquired between the net worth. If the percentage is higher than 60%, it means that the entity is highly indebted.
Long-term debt ratio. It is similar to the previous one, but focuses specifically on the long-term debt ratio. These long-term debts, reflected in the accounting as non-current liabilities, include bank loans, issuance of bonds and other financial obligations that exceed at least 12 months. It is calculated by dividing non-current liabilities by net worth.
solvency ratio. The economic solvency indicator par excellence. Evaluates the ability of an entity to meet its debts with its assets. It is obtained by dividing the total assets by the total liabilities due. If it stays at 1.5, it means that the company, or person, can cope.
Leverage Ratio. Finally, we have the debt indicator. It measures the degree of leverage of an entity and how it affects its profitability. Generally, it is used in companies. Indicates the ratio between debt and equity. It tells us how much debt is used to finance assets compared to equity. It is calculated by dividing assets by net worth. The higher the result, the lower the entity’s ability to finance its investments with its own capital.
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