Solvency and equity ratio

Solvency is a measure of a company's long-term ability to finance its operations. Solvency is a key measure for estimating how healthy a company is. Solvency is synonymous with equity ratio.

A solvency of 100 % means that the company is financed with only equity and a solvency of 0 % means that there is no equity at all in the company. A high equity ratio means low risk and low return, while a low equity ratio means high risk and high return on equity. Companies can increase their return on equity by lowering their solvency, provided that the return on assets is higher than the loan rate.

Solvency (equity ratio) = adjusted equity / total assets
Adjusted equity = shareholders' equity + (1 - corporate tax rate) * untaxed reserves

Untaxed reserves may exist in annual reports to individual companies, untaxed reserves do not exist in consolidated financial statements because the division into an equity component and a debt component is made when the consolidated financial statements are prepared.