Solvency is the ability to pay off debts or the lack thereof.
Solvency is the action and effect of solving or resolving (finding a solution to a problem , unraveling a difficulty, making a determination, recapitulating). The concept, coming from the Latin solvens , is used to name the ability to satisfy debts and the lack thereof.
For example: "The bank must request reports to verify our solvency before granting us credit" , "The company had to make a lot of efforts, but it has finally recovered its solvency" , "Our company needs the loan urgently; Although we have always been characterized by our solvency, we are going through a particularly difficult time .
Solvency analysis
There are specialized agencies and companies that are dedicated to analyzing the solvency of other companies , organizations and even States . For this, they carry out complex studies based on various indicators and finally give a rating according to the ability to pay debts.
An example of a rating on the solvency of an entity is the ranking that goes from A to D. Organizations that receive an A rating are those with maximum payment capacity and full power to meet their debts while, at the other extreme, a D rating indicates great vulnerability and serious risk of non-compliance.
These solvency analyzes allow those who grant credits and loans to know the payment capacity of the organization that contracts the debt. If a D-rated company issues bonds, buyers should be aware of potential collection difficulties. On the other hand, if the debt is rated A , there should be no problems since solvency is virtually guaranteed .
Solvency is usually linked to liquidity.
Differences with liquidity
Both the concept of liquidity and solvency represent two extremely important criteria when rating the economic performance of a company . Since they have certain similarities, they are often confused both in everyday speech and in texts specialized in financial topics.
The liquidity of a company is its ability to convert assets into money immediately, therefore it refers to the possession of certain economic resources. The most liquid of assets is money, since it does not need to go through any process to meet this condition. On the other hand are bonds, bank certificates of deposit and checks.
Assets that cannot be considered liquid assets are vehicles, furniture and real estate, since theoretically they cannot provide their owner with the necessary money instantly.
Given that solvency indicates the possession of the means or properties necessary for an individual or a company to pay its debts, it is possible to have liquidity and not be solvent or, on the contrary, be in a position to satisfy commitments with creditors. but not have assets that can be converted into money easily and immediately.
A clear example of the first situation is a businessman who owns land valued at an amount several times higher than the money he needs to start his activity, but who does not have the cash for this purpose. It is likely that a bank will grant you credit without problems, given that your property represents great solvency and acts as a guarantee for the repayment of the loan; However, the plot is not a liquid asset, and in this case it would be absurd to get rid of it, given that it is essential for the company.
On the other hand, if a person has a large cash capital but does not have property or the means to prove that he is capable of paying off a debt, there is not much chance that a bank will grant him a loan, since his liquidity does not carry his solvency.