Solvency ratio and your business

What is solvency?

Solvency is a number that shows how financially healthy your business is. shows the relationship between equity (private money) and total assets. The result is a percentage that shows whether your business can pay all its bills in the long term. The higher the percentage, the stronger your business is. Solvency is also known as a financial buffer.

Why is solvency important?

Solvency says something about the financial health of your business. High solvency offers business partners such as suppliers more certainty. It shows that you can pay them. Your solvency is also important if you need financing. Higher solvency means that a financier runs less risk and you can usually borrow money at a favourable interest rate.

Companies with good solvency are better able to withstand economic setbacks. You are less dependent on external lenders because your own company pays for a large part of the investments itself.

Solvency is calculated using the following formula:

Divide equity by total assets.

Multiply the result by 100%. This gives you the solvency ratio.

• Equity = value of assets minus liabilities.
• Total assets = equity + borrowed capital (loans)

Solvency calculation example

Is your equity capital €50,000 and your total business capital €150,000? Then your solvency is 50,000 divided by 150,000. Multiply the result by 100%: the solvency is 33%. 

Explanation of elements in calculation

Fixed assets are present in your company for more than a year, such as equipment or property. Current assets are present in your company for less than a year, such as inventory or money owed by customers.

Liabilities are existing debts used to finance your assets. These include contributed equity (own money and funds) and debt (money from third parties). Long-term liabilities have a term of more than one year. Short-term assets have a term of less than one year.

Please note: reserves are included in equity capital. Provisions fall under borrowed capital.

Balance sheet and profit & loss

The balance sheet in your annual accounts shows your equity and total assets. Together with your profit and loss account, the balance sheet forms the financial statements. Think of this as a snapshot of the assets, liabilities and equity in your business at a single moment. It is a snapshot because the balance sheet changes daily: a debtor pays, you purchase goods or pay taxes. You can see this on your interim balance sheet and your profit and loss statement.

Look at your accounts once a month to calculate your solvency ratio. Track the changes over time to gain more insight into the financial fitness of your business.

What is a good solvency percentage?

Financiers consider a good solvency percentage to be between 25% and 40%. However, this varies per sector and company. A large amount of cash (in hand or in the bank) is positive, while stock that is difficult to sell is negative.

High solvency is favourable for financiers. It increases the likelihood that you will be able to repay the financing. The solvency standard used by financiers varies depending on the sector, type of company and financier.

Keep your business administration up to date

Review your accounts regularly. For example, check your interim balance sheet and profit and loss account once a month. Use the figures to calculate your solvency and assess any increase or decrease.

Improve your solvency

Depending on your situation there are various ways to improve your solvency. A financial advisor can help you find the best solution for your business. Consider these options:

• Ask your customers to pay on time. Fewer outstanding invoices mean more money in your account. You will borrow less for working capital. As the loan capital on your balance sheet decreases, your solvency ratio increases.
• Consider factoring. Pre-financing invoices reduce the number of days you wait for invoices to be paid and the number of outstanding debtors.
• Optimise your inventory. Money is locked up in your goods until they are sold. The smaller your inventory, the lower your total assets. Lower total assets with the same equity mean a higher solvency ratio.
• Ask your supplier for a discount if you pay quickly. This gets you a higher return on surplus cash.
• Distribute less profit (dividends). Keep profit in your company and add it to the general reserves. This increases equity.
• Increase your profits. Extra profit means more equity. Increase your income or cut costs for higher profitability. Be critical of your purchasing and sales prices.
• Invest your own money in the business. Invest private capital in your business or buy back shares.