If you have borrowed a lot of money from the bank, the bank runs much more risk than if your business consists largely of equity. Suppose your company goes bankrupt, the bank will still get (part of) the borrowed money back by selling your own assets. When your debts exceed your own assets, the bank is more at risk of losing the money.
What is solvency used for?
Many companies cannot simply make a new investment because they do not have the means to pay for an investment out of their own pocket. If they need a loan for this, the lender will want to know what the balance between equity and loan capital looks like. As an entrepreneur, are you able to pay off debts in the short or long term? The business calculator works perfect in the calculations.
Calculate solvency ratio
Solvency can be calculated in three different ways. The outcome of this calculation is also referred to as the solvency ratio or solvency percentage. The balance sheet of your company is always the starting point for calculating the solvency ratio.
Calculation 1: total assets / debt
In this calculation, you add up all assets. These are the so-called assets and you will (almost) always find them on the left side of the balance sheet. On the right-hand side, add up the loan capital. You divide the total assets by the loan capital.
Solvency calculation 1 Total assets / debt x 100 = solvency ratio
Suppose you have a total of 35,000 euros in assets and a loan capital of 20,000 euros. Then your solvency ratio is (35,000 / 20,000 x 100) = 175. In that case, € 1 is borrowed from every € 1.75.
Calculation 2: equity / debt
You can also calculate with the total equity capital and the total loan capital. This calculation does not have the same result as calculation 1. This is always exactly 100% less than with calculation 1. This calculation shows how many times greater your equity capital is than the loan capital.
Solvency calculation 2 Equity / debt x 100 = solvency ratio
Suppose you have EUR 15,000 in equity and EUR 20,000 in loan capital, then you have a solvency ratio of (15,000 / 20,000 x 100) = 75. This means that your equity capital is 0.75 times greater than the loan capital.
Calculation 3 (solvency percentage): equity / total assets
In this calculation, you divide the equity by the total assets. With this calculation you calculate for what percentage of your total capital consists of equity.
Solvency calculation 3 Equity / total assets x 100 = solvency ratio
You have EUR 15,000 in equity and your total assets are EUR 35,000. That means that your solvency percentage (15,000 / 35,000 x 100) = 42.86%. Your company therefore consists of almost 43 percent in equity.
Healthy solvency ratio
After the calculation you would of course like to know whether the results are good or bad. The higher is the outcome, the better is your solvency. But that does not mean that a low solvency ratio means that your business is not doing well. This differs per company. A solvency ratio between 25% and 40% (calculation 3) is usually seen as good.