Ministry of Higher and Secondary Special Education of the Republic of Uzbekistan Tashkent State University of Economics

The analysis of the solvency of the organization

Solvency analysis is the process whereby it is analyzed whether a company is able to meet its long-term obligations. In other words, analyzing a firm’s ability to pay its long-term financial obligations along with the interest associated with debt on time is referred to as solvency analysis.
Every organization procures some funds from various external sources on which they have to pay interest or rewards, such as dividends on equity capital. To assess a company’s ability to repay debt or interest that is of long-term nature is known as solvency analysis. When the company’s ability to pay its short-term obligations is assessed or evaluated, then it is called liquidity analysis. The purpose of solvency analysis is to prove that a business can pay the interest on a timely basis and is also capable to make payment of the principle amount when the debt matures.
The solvency analysis is a part of financial analysis. The solvency of a company can be broadly determined by two factors that are the company’s current assets and its current liabilities. The working capital of the company reveals the exact position of the company’s short-term solvency as the company is capable of paying its debt until its current liabilities exceed its current assets. The long-term solvency of the company can be assessed by indicators such as present net worth, debt-equity ratio, loan repayment scheduled, and interest coverage.
The solvency ratio is the ratio of net income before depreciation after total liabilities. Total liabilities include both short-term liabilities as well as long-term liabilities. It is given by the following formula:
Solvency ratio= (Net profit after tax + Depreciation)/Total liabilities⁷
Solvency ratios provide key metrics to assess whether the company is capable of meeting its long-term and short-term obligations on a timely basis. Following are some solvency ratios:

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  Debt-to-Equity Ratio: Debt-to-equity ratio measures the debt capital, which the company procures from outside sources as compared to the proportion of equity capital. This ratio can be calculated using the following formula:
  

Debt-to-equity ratio=Total liabilities/Total shareholder’s capital⁸
This ratio indicates the company’s paying capacity. A higher ratio indicates a weaker solvency of the company.

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