What is the solvency ratio?
A company funds everything it owns in two ways: with the owners' money (equity) or with other people's money (debt and provisions). The solvency ratio, also called equity ratio, tells you what share of the total comes from the owners.
A high solvency ratio is a buffer. If the company makes a loss, it comes off equity first. The larger that buffer, the longer the company can absorb setbacks without putting its creditors at risk. That is why banks and suppliers often look at it first.
The formula
Solvency ratio = equity ÷ balance sheet total × 100
Equity: item 10/15. Balance sheet total: item 20/58.
Both figures are on the balance sheet, in every format of Belgian annual accounts (micro, abridged and full). Those formats follow the European Accounting Directive. Equity consists of contributions or capital, reserves and profit or loss carried forward. The balance sheet total is the sum of all assets, and therefore also of all liabilities.
Some analysts compare equity with liabilities instead, or deduct intangible assets first. Always compare figures that were calculated the same way.
Example: Bakkerij De Zoete Korst
Bakkerij De Zoete Korst is a fictitious bakery with a balance sheet total of €500,000. Its equity is €200,000: €20,000 contributed, €120,000 reserves and €60,000 profit carried forward. The rest, €300,000, is debt.
- Fixed assets
- Current assets
- Equity
- Debt due after one year
- Debt due within one year
- Step 1
Find equity
Take item 10/15 on the liabilities side of the balance sheet.
€20,000 + €120,000 + €60,000 = €200,000 - Step 2
Find the balance sheet total
Take item 20/58: total assets.
€500,000 - Step 3
Divide and multiply by 100
The bakery funds 40% of everything it owns with its own money.
€200,000 ÷ €500,000 × 100 = 40%
What is a good solvency ratio?
There is no legal threshold. Nummo uses these rules of thumb, which many banks and accountants use as well:
- < 15%thin buffer
- 15% – 30%acceptable
- 30% – 50%healthy
- ≥ 50%strong
These are rules of thumb, and they differ by sector. A wholesaler works with a lot of supplier credit and often sits lower without anything being wrong. A consultancy needs little to operate and often sits higher. Preferably compare a company with companies in the same sector and of the same size.
A very high solvency ratio is safe, but not always efficient: the company then uses little outside money to grow, and return on equity is often lower.
Look at the trend
One year says little. At Bakkerij De Zoete Korst, the solvency ratio rose in five years from 26.7% to 40%, because the bakery kept its profit in the business every year.
- rule of thumb 30%
How does a company improve its solvency ratio?
- Keeping profit in the company instead of paying it out: reserves grow.
- A new contribution or capital increase by the owners.
- Paying down debt, for example with surplus cash.
- A subordinated loan from the owners is still debt in the accounts, but banks sometimes treat it as quasi-equity.
Calculate it yourself
Enter the figures from a set of annual accounts. The fields start with the bakery example.