Solvency Definition - What it is, Meaning and Concept

Solvency (from Latin solvens ) is the action and effect of solver or solve (find solution to a problem , unleash a difficulty, make a determination, recap).The concept is used to name the ability to meet debts and the lack of these.

For example: "The bank must request reports to verify our solvency before granting us credit" , "The company had to work hard, but it has finally regained solvency" , “Our company urgently needs the loan; Although we have always been characterized by our solvency, we are going through a particularly difficult time ”.

There are specialized agencies and companies 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 They grant a rating according to the ability to pay debts.

An example of a bank's solvency rating is the ranking that goes from A to the D .Organizations that receive a A rating are those with maximum capacity to pay and full power to meet their debts while, at the other end , the D grade indicates a high 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 company with D rating issues bonds, buyers should take into account the Potential difficulties for collection.On the other hand, if the debt has A rating , no problems should be recorded since solvency is virtually guaranteed.

Differences with liquidity

Both the concept of liquidity and solvency represent two very important criteria when qualifying the economic performance of a company.Given that they have certain similarities, they are often confused both in everyday speech and in specialized texts in financial matters.

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 the assets is money, since it does not need to go through any process to comply with this condition.On the other hand are bonuses, bank certificates of deposit and checks.

The goods that cannot be considered as liquid assets are vehicles, furniture and real estate, since theoretically they cannot provide their owner with the necessary money instantly.

Since solvency indicates the possession of the necessary means or property so that an individual or a company pays its debts, it is possible to have liquidity and not be solvent or, on the contrary, be in a position to meet the commitments with creditors but not having assets that can be converted into money easily and immediately.

A clear example of the first situation is an entrepreneur 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 that purpose.It is likely that a bank will grant a credit without problems, since your property represents a high solvency and acts as a guarantee of 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, since it is indispensable for the company.

On the other hand, if a person has a large cash capital but does not own property or the means to prove that he is able to pay off a debt, there is not much chance that a bank will grant him a loan, since his liquidity does not result in solvency.