Solvency ratios, also known as leverage ratios, measure a company’s ability to meet its long-term financial obligations by assessing the relationship between debt and equity.
Primary Implication
Solvency Ratios matter to any business that is trying to secure debt or equity financing and those working to sell their business.
The relationship between debt and equity on the right-hand side of a company’s balance sheet tells how much financial leverage has been used to acquire assets. A business with too much debt will be challenged to prove that it can sustain operations before anyone would choose to lend or invest in a business.
Overview
Financial leverage is the relationship between debt and equity on the right-hand side of a company’s balance sheet. Increasing leverage means increasing the proportion of debt to equity.
Solvency Ratios measure a company’s ability to sustain operations indefinitely by comparing debt levels with equity, assets, and earnings. Below are the three most commonly used solvency ratios:
Solvency ratios are also called Leverage Ratios.