The structural financial property that determines long-term survival. Where liquidity is about meeting next month's bills, solvency is about whether the business can sustain itself over years.
Definition
Solvency - the long-term ability of a business to meet all its financial obligations. Measured by capital structure ratios (debt-to-equity, debt-to-asset) and earnings coverage (interest coverage).
Common uses
- Lender risk assessment - banks evaluate solvency before extending long-term credit
- Investor analysis - capital structure is one of the first things sophisticated investors examine
- Strategic decisions - debt-heavy businesses have less strategic flexibility
Watch out
A business can technically be insolvent (liabilities exceed assets) for a while before it becomes obvious - especially if cash flow temporarily covers debt service. Watch the balance sheet, not just the bank account.