Solvency Ratio Formula (Table of Contents)
- Solvency Ratio Formula
- Examples of Solvency Ratio Formula (With Excel Template)
- Solvency Ratio Formula Calculator
Solvency Ratio Formula
Here’s the Solvency Ratio formula –
Examples of Solvency Ratio Formula (With Excel Template)
Let’s take an example to understand the calculation of Solvency Ratio formula in a better manner.
Example #1
An ltd made a profit for this financial year-end after tax is 10000. The company is having an asset of Rs 10000. The depreciation rate applicable as per Company law is 10% (Straight-line method). Long-term and short-term liability are 50000. From the above information, calculate the solvency ratio.
Solution:
Solvency Ratio is calculated using the formula given below
Solvency Ratio = (Net Profit After Tax + Depreciation) / Total Liability
- Solvency Ratio = (10000 + 1000) / 50000
- Solvency Ratio = 22%
Thus, the above ratio indicates that the company has a short-term and long-term liability over a period of time. The solvency ratio differs from industry to industry, so the solvency ratio greater than 20 is considered that the company is financially healthy. Higher the solvency ratio good for the company and vice versa.
Example #2
Dmart have the following information available for the financial year-end. So, calculate the solvency ratio from below information. The depreciation rate is 10 %, use the straight-line method for calculating depreciation. And the tax rate is 30%.
Solution:
Net Profit Before Tax is calculated as:
- Net Profit Before Tax = 1,60,000 – 90,000 – 40,000
- Net Profit Before Tax = 30,000
Tax Rate is calculated as:
- Tax Rate = 30,000 * 0.3
- Tax Rate = 9,000
Net Profit After Tax is calculated as:
- Net Profit After Tax = 30,000 – 9,000
- Net Profit After Tax = 21,000
Long Term Liabilities is calculated as:
- Long Term Liabilities = 20,000 + 18,000 + 39,000 + 9,000
- Long Term Liabilities = 86,000
Short Term Liabilities is calculated as:
- Short Term Liabilities = 15,000 + 5,000 + 2,000 + 10,000 + 6,000 + 4,000 + 3,500
- Short term liabilities = 45,500
Depreciation is calculated as:
- Depreciation = 1,80,000 * 0.1
- Depreciation = 18,000
Solvency Ratio is calculated using the formula given below
Solvency Ratio = (Net Profit After Tax + Depreciation) / (Short Term Liability + Long Term Liability)
- Solvency Ratio = (21,000 + 18,000) / (45,500 + 86,000)
- Solvency Ratio = 30%
Example #3
Tata sponge has the following information, the tax rate is 35% and depreciation rate is 10%. Calculate the solvency ratio for the below information.
Solution:
Net Profit Before Tax is calculated as:
- Net Profit Before Tax = 1,20,000 – 50,000 – 20,000
- Net Profit Before Tax = 50,000
Tax Rate is calculated as:
- Tax Rate = 50,000 *0.35
- Tax Rate = 17,500
Net Profit After Tax is calculated as:
- Net Profit After Tax = 50,000 – 17,500
- Net Profit After Tax = 32,500
Short Term Liabilities is calculated as:
- Short Term Liabilities = 5,000 + 14,000 +16,500 +12,000 + 7,000
- Short Term Liabilities = 54,500
Long Term Liabilities is calculated as:
- Long Term Liabilities = 20,000 + 15,000 + 8,000
- Long Term Liabilities = 43,000
Depreciation is calculated as:
- Depreciation = 50,000 *0.1
- Depreciation = 5000
Solvency Ratio is calculated using the formula given below
Solvency Ratio = (Net Profit After Tax + Depreciation) / (Short Term Liability + Long Term Liability)
- Solvency Ratio = (32,500 + 5,000) / (54,500 + 43,000)
- Solvency Ratio= 38%
Explanation of Solvency Ratio Formula
Solvency ratio is one of the quantitative measures used in finance for judging the company financial health over a long period of time. Solvency ratio used by the creditor to know the ability of a company for paying their short and long term liability. In finance, solvency ratio play a very vital role for judging the company ability for making payment of their long term and short term over a period of time.
Solvency ratio basically indicates that the cash flow of a company is sufficient to pay its liabilities and obligation or not. Lower the solvency ratio there are more chances that the company will make default in paying their debt and vice versa. It is always favorable if a company have higher solvency ratio.
In solvency ratio, many terms and amount took into consideration for calculating. Solvency ratio includes net profit after tax and depreciation from profit and loss statement, and long term and short term liability from the balance sheet. For the purpose of calculating depreciation, we have to take into consideration the total asset from the balance sheet.
Solvency ratio includes three steps for calculation. The first step is to calculate net profit to the company after excluding all expenses and taxes. The second step is to calculate depreciation on the asset, and the last step is to calculate short term and long term liability. Solvency ratio is very important from the point of view of creditor and the debenture holder who wants to invest in the company by the way of giving credit or investing in debenture so solvency ratio formula is very important to know the creditworthiness of company in the long run and help to know the company financial stability.
Relevance and Uses of Solvency Ratio Formula
Solvency ratios have relevance in finance. Solvency ratio having much more importance because company financial health is the major concern for each and every business and company itself.
- Solvency ratio having relevance in the field of commerce and finance.
- For knowing the financial stability of a company
- For ensuring the amount which is invested by the creditor in the form of credit sale to a company
- For ensuring the debenture holder who gave credit to the company in the exchange of interest.
- Cash flows are sufficient to pay its obligation in the long run
- To know the creditworthiness of the company
- To know the liquidity of the company in the long run.
Calculator
You can use the following Solvency Ratio Calculator.
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