Solvency

Solvency looks at the overall financial position. A solvent business has enough assets, over time, to cover everything it owes. An insolvent one owes more than it owns or cannot pay its debts as they become due.

Solvency is different from liquidity. Liquidity is about having cash available now; solvency is about the long-term balance between assets and debts. A company can be solvent but illiquid, owning valuable factories but lacking cash this month. It can also be liquid but heading towards insolvency, holding cash today while losing money and building up debts it will never be able to repay.

For example, a business with assets of 2 million and debts of 1.5 million is solvent, because its assets exceed its liabilities by 500,000. If losses shrink its assets to 1.2 million while debts stay at 1.5 million, it becomes insolvent.

Lenders, investors and regulators watch solvency closely. Banks and insurers must meet minimum solvency or capital requirements, and directors of a company that becomes insolvent often have special legal duties to protect creditors.