Corporate Fin Mgt NDLM.PDF

29. Solvency ratio

29.1. The portion of the shareholder funds (SHF) out of the total liabilities

determines the solvency of a company. The higher the SHF when compared

to other liabilities in total, the greater the solvency and the vice-versa.

29.2. The share holders’ funds are also known as ‘owner’s equity’.

29.3. High solvency ratio means that the SHF portion in the total liabilities is high

representing capacity to borrow more money from outside. Low solvency

ratio means that SHF portion in the total liabilities is low and indicates that

there is less scope to borrow money from outside. The solvency ratio is

often expressed as a percentage.

29.4. The two measures of liquidity are (a)Current ratio and (b) Quick ratio

29.5. Current Ratio is measured by the following formula:

CR = CA: CL

Where CR - Stands for current ratio

CA stands for current assets and

CL stands for current liabilities

29.6. Quick Ratio is measured by the following formula:

QR = QA: CL

Where QR stands for quick ratio

QA stands for quick assets and

CL stands for current liabilities

29.7. To measure general liquidity, current ratio is required. To measure

immediate liquidity, quick ratio is required.

29.8. In business, the harsh reality is that cash is more important than profit.

Therefore, there must be a situation of higher portion of current assets when

compared to current liability, so that the current ratio will always be positive

i.e., more than one. To calculate the current ratio, the marketable securities

should always be included.