Solvency is the status of a person or entity who has sufficient assets to cover their liabilities. It is distinguished from insolvency, in which a person is unable to pay their debts and may possibly file for bankruptcy.
Different methods exist for determining the solvency or liquidity of a company. These ratios seek to determine the ability of a firm to avoid financial distress in the short-run. The two most important short-term solvency ratios are the current ratio and the quick ratio. The current ratio is calculated by dividing current assets by current liabilities. The quick ratio is calculated by dividing current assets less inventories by current liabilities.
