What does the term 'solvency' refer to?

The term 'solvency' specifically refers to the ability of a company to meet its long-term debts and obligations. This is a critical measure of a company's financial health, as it indicates its capacity to sustain operations over the long term without risking bankruptcy. Solvency is assessed through various financial ratios that compare the company’s total assets to its total liabilities. A solvent company has enough assets to cover its debts, providing assurance to creditors and investors regarding the long-term viability of the business.

In contrast, the ability to convert assets into cash quickly pertains to liquidity, focusing on short-term obligations and immediate financial obligations rather than long-term. Profitability relates to how well a company generates income relative to its expenses, which is separate from its solvency position. The ratio of liabilities to equity is related to a company’s capital structure and can indicate financial risk but does not directly define solvency itself. Understanding solvency is essential for assessing a company’s long-term risk and stability.