The solvency ratio of a business: a pillar of financial health
Main ratios
- Solvency ratio (equity / total assets): the share of assets financed by owners;
- Debt-to-equity ratio (total debt / equity): financial leverage;
- Interest coverage ratio (EBIT / interest expense): ability to pay interest;
- Current ratio (current assets / current liabilities): short-term liquidity.
Why they matter
Banks and investors use these ratios to assess risk. Loan agreements often contain financial covenants (for example, a minimum debt service coverage ratio); breaching them is an event of default that allows the lender to demand repayment or renegotiate.
Insolvency in law
Under the Bankruptcy and Insolvency Act (s. 2), an insolvent person is one who cannot meet their obligations as they become due, has ceased paying them, or whose property is insufficient to pay all obligations. Corporate law also prohibits paying dividends or redeeming shares if the corporation would then be unable to pay its debts (Business Corporations Act (Quebec), s. 104; CBCA, s. 42). Directors who authorize such payments may be personally liable.
Improving solvency
Retaining earnings, injecting capital, converting debt to equity, refinancing over a longer term and reducing non-essential assets.
