In finance, being solvent means being able to pay one’s debts.
Solvency is defined as an entity’s ability to settle financial obligations. In the corporate framework, the company must also have the ability to handle long-term expenses, while still being able to expand.
If a company becomes insolvent, it will no longer be able to continue operations. In this case, the company will have to file for bankruptcy. It is through this that it will be able to liquidate its assets or undergo the necessary restructuring. Solvency is therefore a good indicator of a company’s financial health.
The debt equity ratio is one of the ways by which a company’s degree of solvency can be measured.
Solvency is quite different from profitability, although it is common to assume that profitable businesses are also solvent. This is probably because a company which consistently makes profit is more likely to have the resources to settle its bills.
There are exceptions to this, as it is possible for a company to be profitable while it is burdened by insolvency, as in the case of new businesses which are experiencing very rapid growth. In the same way, companies can also be unprofitable, but still be solvent, if they take advantage of their receivables.
Solvency also applies to individuals who have been previously mired in credit card debt and have since decided to put a stop to further accumulation of debt. This is therefore an important factor for banks or other financial institutions to consider before deciding on whether a new loan should be granted to the individual.