Solvency in the construction industry
‘Solvency’ describes the ability of a company to service its debts. In very simple terms, to be solvent, the value of a company’s assets must be greater than the sum of its debts.
A company that is not solvent can still continue to operate in the short term, for example, if the company takes on debt with the intention of expanding their operations and growing business. In the short term, they may be unable to service the debt from their existing assets. However, the creditor assumes that increased revenue from the investment will enable the company to service its debts in the longer-term.
Short-term solvency can be measured by the current ratio – calculated by dividing current assets by current liabilities. The solvency ratio can be used to measure longer-term solvency – calculated by dividing the company’s net income + depreciation by its long term and short term liabilities.
In the UK, an insolvent company is one that is unable to service its debts. Insolvent companies may be put into 'liquidation' or 'administration'.
For more information, see Insolvency in the construction industry.
Solvency is not the same as liquidity, which refers to the availability of liquid assets (i.e. cash), and how easy it is for other assets to be converted to cash.
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