Solvency refers to the ability of a company to fulfill or pay its long-term obligations, i.e., the obligations that are due for settlement after the period of one year. Solvency ratios provide information concerning the debt of a company in comparison to its capital mix and the cushion of earnings and cash flow to cover any dues such as the interest payment on a debt, repayment of long-term obligations, and other fixed charges.
Therefore, at times, a company with low debt can show a high solvency ratio, but if the company’s cash management practices are not robust, it might not be as solvent as indicated by its solvency ratio due to low debt. For example, if a company’s accounts receivable is slow, it could eventually impact accounts payable, and, in turn, the solvency of the company.
