What does the term "solvency" refer to?

The term "solvency" refers specifically to a company's ability to meet its long-term obligations. This is a crucial measure of financial health, indicating whether the entity has sufficient assets to cover its liabilities over the long run. Solvency focuses on the balance sheet and provides insights into the overall financial stability of the company. A solvent company is one that can pay its long-term debts and continue operations over time without facing bankruptcy.

Understanding solvency is important for stakeholders such as investors, creditors, and management, as it assesses the company’s ability to sustain operations and manage debt over the long term, ensuring it can survive any financial crises or downturns. This distinguishes it from liquidity, which deals with short-term obligations, typically assessed through current ratios or quick ratios.