CBSE Class 12 Commerce Accountancy Solvency Ratios Complete Information
CBSE Class 12 Commerce Accountancy Solvency Ratios : CBSE is a well-known educational board of India. Several praise worthy distinctions give this board an esteemed outlook in all respects. It provides well-revised syllabus for all classes. The concerned department of CBSE conducts required research and based on that it revises its syllabus and educational system from time to time. To meet its noble objective, CBSE board not only offers updated syllabus, but also encourages students in learning by providing robust and state-of-the-art environment.
CBSE Class 12 Commerce Accountancy Solvency Ratios Complete Information
CBSE Class 12 Commerce Accountancy Solvency Ratios : The solvency ratio of an insurance company is the size of its capital relative to all risks it has taken. The solvency ratio is a measure of the risk an insurer faces of claims that it cannot absorb. The amount of premium written is a better measure than the total amount insured because the level of premiums is linked to the likelihood of claims. Different countries use different methodologies to calculate the solvency ratio, and have different requirements. For example, in India insurers are required to maintain a minimum ratio of 1.5.
A measure of a company’s ability to service debts, expressed as a percentage. It is calculating by adding the company’s post-tax net profit and depreciation, and dividing the sum by the quantity of long-term and short-term liabilities; the resulting amount is expressed as a percentage. A high solvency ratio indicates a healthy company,while a low ratio indicates the opposite. A low solvency ratio further indicates likelihood of default. Different industries have different standards as to what qualifies as an acceptable solvency ratio, but, in general, a ratio of 20% or higher is considered healthy. Potential lenders may take the solvency ratio into account when considering making further loans.
The solvency of an insurance company corresponds to its ability to pay claims. The Solvency ratio is a way investors can measure the company’s ability to meet its long term obligations An insurer is insolvent if its assets are not adequate [over indebtedness] or cannot be disposed of in time to pay the claims arising. In other words, it is the extra capital that an insurance company is required to hold. As per the IRDA (Assets, Liabilities, and Solvency Margin of Insurers) Rules 2000, both life and general insurance companies need to maintain solvency margins.
life insurance companies are expected to maintain a 150% solvency margin. The higher the ratio is the better equipped a company is to pay off its debts and survive in the long term. All insurance companies have to pay claims to policy holders. These could be current or future claims of policy holders. Insurers are expected to put aside a certain sum to cover these liabilities. These are also referred to as technical provisions. Insurance, however, is risky business and unforeseen events might occur sometimes, resulting in higher claims not anticipated earlier. For instance, calamities like the Mumbai floods, J&K earthquake, fire, accidents of a large magnitude, etc may impose an unbearable burden on the insurer.
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CBSE Class 12 Commerce Accountancy Solvency Ratios Complete Information
CBSE Class 12 Commerce Accountancy Solvency Ratios : This article explains the Solvency Ratio in a practical way. After reading you will understand the basics of this powerful financial management tool. The solvency ratio of an organization gives an insight into the ability of an organization to meet its financial obligations. Solvency also indicates how much the organization depends on its creditors and banks can use this when the organization applies for a credit facility.
Solvency Ratio formula
The solvency ratio is a calculation formula and solvency indicator that demonstrates the relationship between the various equity components.
There are two ways to calculate the solvency ratio:
Solvency Ratio I = | Equity* / Total Assets** | x 100% |
* = Equity is the capital that the entrepreneur has invested in the organization.
** = Total assets is the capital that is incorporated in the organization, these are the Equity, the Short-Term Liabilities (the
capital that has to be repaid in the short- term, for instance a suppliers credit, creditors or overdraft facility) and the Long-Term Liabilities (long-term liabilities that can be repaid after more than one year).
In order to determine whether an organization is viable, the outcome should be between 25% and 40%.
This is of course dependent on the industry and type of undertaking.
This also says something about the financial health of an organization but this does not necessarily mean that they are going bankrupt.
The second manner is about the weighing of the assets with respect to the Total Liabilities.
The calculation is as follows:
Solvency Ratio II = | Total Assets* / Total Liabilities** | x 100% |
* = Total Assets is the sum of assets of an organization. This is divided into current assets (these are the assets of a person, company or organization in which the capital is contributed for a period of less than one year). The current assets must be converted into money within one year. Examples of current assets are stock, receivables and liquid assets) and fixed assets (these are for example buildings, inventory, machines and plants and vehicles)
** = Total Liabilities are the total liabilities that are incorporated in the organization, these are the Short-Term Liabilities and the Long-Term Liabilities.
The higher the outcome in percentages the more solvent the organization is.
CBSE Class 12 Commerce Accountancy Solvency Ratios Complete Information
CBSE Class 12 Commerce Accountancy Solvency Ratios : Solvency ratios, also called leverage ratios, measure a company’s ability to sustain operations indefinitely by comparing debt levels with equity, assets, and earnings. In other words, solvency ratios identify going concern issues and a firm’s ability to pay its bills in the long term. Many people confuse solvency ratios with liquidity ratios. Although they both measure the ability of a company to pay off its obligations, solvency ratios focus more on the long-term sustainability of a company instead of the current liability payments.
Solvency ratios show a company’s ability to make payments and pay off its long-term obligations to creditors, bondholders, and banks. Better solvency ratios indicate a more creditworthy and financially sound company in the long-term.
Solvency ratios measure the ability of a company to pay its long-term debt and the interest on that debt. Solvency ratios, as a part of financial ratio analysis, help the business owner determine the chances of the firm’s long-term survival. Solvency ratios are sometimes confused with liquidity ratios. Both assess a company’s financial health.
But solvency ratios assess the company’s long-term health evaluating long-term debt and the interest on that debt; liquidity ratios assess the company’s short-term ability to meet current obligations and turn assets into cash quickly.
What Are Solvency Ratios Good for?
Solvency ratios are of interest to long-term creditors and shareholders. These groups are interested in the long-term health and survival of business firms. In other words, solvency ratios have to prove that business firms can service their debt or pay the interest on their debt as well as pay the principal when the debt matures.
Solvency ratios also help the business owner keep an eye downtrends that could eventuate in a possible bankruptcy. As the Debt/Asset ratio increases, the likelihood of bankruptcy also increases as the firm is financed more and more with debt as opposed to equity sources.
Solvency Ratios
There are several different solvency ratios, some of them technical and of use primarily to auditors or corporate analysts, others easily assessed and of interest to professional accountants, business owners and shareholders alike. A few of these basic solvency ratios are:
- The Total Debt/Total Assets Ratio, measures how much of the firm’s asset base is financed using debt. If a firm’s debt ratio is .5, that means for every dollar of debt there are two asset dollars, or, putting it another way, that the firm’s equitytotals twice its debt.
- The Equity Ratio explains how much of the company is owned by its investors. The Equity Ratio is calculated by dividing total equity by total assets. It answers a basic, but very important question: if the company goes out of business after it pays all liabilities how much will be left for its investors.
- Interest Earned measures a company’s ability meet its long-term debt obligations. It’s calculated by dividing corporate income before interest and income taxes (commonly abbreviated EBIT) by interest expense related to long-term debt.
What Is a Good Solvency Ratio?
There’s no one-size-fits-all good solvency ratio. In order to evaluate a given firm’s solvency ratio, you need to compare it with the industry average. One way of quickly getting a handle on the meaning of a company’s solvency ratios is to compare them with the same ratios for a few of the dominant players in your firm’s financial sector.
Relatively minor deviations from the ratios of the dominant players (which will also differ from one to another) are likely not meaningful. If one of the ratios shows limited solvency, that’s a problem. If several of these ratios all point to low solvency, that’s a determining issue.
For a potential investor, for instance, these are serious indications of problems ahead; such a company is unlikely to fair well in a stressful economic environment.
BREAKING DOWN ‘Solvency Ratio’
Solvency ratio, with regard to an insurance company, means the size of its capital relative to the premiums written, and measures the risk an insurer faces of claims it cannot cover.
The solvency ratio is only one of the metrics used to determine whet
CBSE Class 12 Commerce Accountancy Solvency Ratios Complete Information
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