Solvency is commonly assessed using which ratio as a guide?

Solvency is commonly assessed using which ratio as a guide?

• A. Current ratio
• B. Debt to equity ratio
• C. Quick ratio
• D. Net profit margin

Answer: (B)

Solvency concerns a company's long-term ability to meet its obligations. The debt-to-equity ratio captures this by showing how much of the financing comes from creditors versus owners. It compares total liabilities to shareholders’ equity, revealing the level of leverage and long-run financial risk. A higher ratio means more reliance on debt, which can strain a company if cash flows weaken, making solvency harder to maintain over time. The other ratios don’t target long-term viability in the same way. Current and quick ratios assess short-term liquidity—whether the business can cover immediate obligations—not its ability to stay solvent over the longer horizon. Net profit margin reflects profitability, not the capacity to endure long-term debts and obligations.

Solvency concerns a company's long-term ability to meet its obligations. The debt-to-equity ratio captures this by showing how much of the financing comes from creditors versus owners. It compares total liabilities to shareholders’ equity, revealing the level of leverage and long-run financial risk. A higher ratio means more reliance on debt, which can strain a company if cash flows weaken, making solvency harder to maintain over time.

The other ratios don’t target long-term viability in the same way. Current and quick ratios assess short-term liquidity—whether the business can cover immediate obligations—not its ability to stay solvent over the longer horizon. Net profit margin reflects profitability, not the capacity to endure long-term debts and obligations.