Solvency refers to the ability to pay your bills as they fall due and, having Assets that are of greater value than your Liabilities.
The success of your business relies on maintaining solvency.
Make sure you understand the steps below on how to assess solvency and be ready to take action immediately if you get into a situation where steps need to be taken.
1. Calculate your Current Ratio
In order to assess whether you have the ability to pay your debts as they fall due, you can calculate your Current Ratio.
Current Ratio = Current Assets divided by Current Liabilities.
A ratio less than one means you don’t have enough current assets to pay your current debts as they fall due and that your business is insolvent.
2. The second part of the test is as follows:
Total Assets minus Total Liabilities.
If the result is negative, this means that your business requires a short-term cash injection.
In either circumstance action must be taken immediately to increase assets. No agreements should be entered into by directors that could create risk to creditors if you are aware that your business is insolvent.