Solvency
Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth. This is best measured using the net liquid balance formula. This formula calculates solvency by adding cash and cash equivalents to short-term investments, then subtracting notes payable [Wikipedia].
Solvency portrays the ability of a business (or individual) to pay off its financial obligations. For this reason, the quickest assessment of a company’s solvency is its assets minus liabilities, which equals its shareholders’ equity. There are also solvency ratios, which can spotlight specific areas of solvency for deeper analysis. Many companies have negative shareholders’ equity, which indicates insolvency. Negative shareholders’ equity insinuates that a company has no book value. If a company must close, this could even lead to personal losses for small business owners if not protected by limited liability terms. In essence, if a company were required to close down immediately, it would need to liquidate its assets and pay off all of its liabilities, leaving only the shareholders’ equity as a remaining value. Carrying negative shareholders’ equity on the balance sheet is usually typical for newly developing private companies, startups, or recently offered public companies. As a company matures, its solvency position typically improves. However, certain events may increase solvency risk, even for well-established companies. In the case of business, the pending expiration of a patent can pose risks to solvency, as it will allow competitors to produce the product in question, resulting in a loss of associated royalty payments [Investopedia].
Solvency. Wikipedia. Retrieved from: https://en.wikipedia.org/wiki/Solvency#cite_note-Ji_2021-4
What Is Solvency? Definition, How It Works With Solvency Ratios. Investopedia. Retrieved from: https://www.investopedia.com/terms/s/solvency.asp