What is Solvency? How to Assess a Company's Financial Strength

Solvency describes how well a business is financed and its capacity to withstand losses over time. The equity ratio is the most common measure.

Formula for Equity Ratio

Equity Ratio = Shareholder Equity / Total Assets × 100

If a company has 4 million Norwegian kroner (NOK) in shareholder equity and 10 million NOK in assets, the equity ratio is 40 per cent.

What Does High or Low Solvency Mean?

A high equity ratio typically provides a larger buffer against losses and reduces reliance on lenders. A low equity ratio does not automatically mean the business is weak. Stable cash flow, valuable assets, and predictable operations can support more debt. Industry and business model are crucial.

Negative equity is a clear warning sign but must be assessed in conjunction with recent figures, financing, and board measures. The annual report is historical and may be outdated.

Solvency is Not Liquidity

A solvent company may lack short-term cash. Conversely, a company with ample cash may be weakly capitalised. Solvency is about a long-term loss buffer, while liquidity is about the ability to meet payment obligations when due.

What Should Be Examined?

• trend in equity over several years
• proportion of intangible assets and goodwill
• debt maturity and collateral
• dividends and capital changes
• group contributions (konsernbidrag) and transactions with related parties
• whether the figures apply to the company or the group

How Proffi Should Present Solvency

Show the equity ratio with a transparent formula and underlying balance sheet items. Compare with relevant industries and use the same type of financial statements. Avoid presenting a colour or rating without thresholds and explanation.