Solvency is best measured by

Solvency is best measured by

• A. Net capital ratio
• B. Current ratio
• C. Debt-to-asset ratio
• D. Working capital

Answer: (A)

Solvency reflects long-term financial strength and the ability to meet obligations over time. The net capital ratio does this by comparing the owners’ equity (net worth) to total assets, showing how much of the assets are funded by the business’s own capital rather than debt. A higher net capital ratio indicates a larger equity cushion to absorb losses and support ongoing operations, which is the essence of solvency. In contrast, liquidity measures like current ratio or working capital focus on short-term ability to cover current liabilities, not long-term sustainability. The debt-to-asset ratio looks at leverage, but it doesn’t directly convey how much of the assets are backed by the owners’ capital. So the net capital ratio best captures the long-run solvency of the business.

Solvency reflects long-term financial strength and the ability to meet obligations over time. The net capital ratio does this by comparing the owners’ equity (net worth) to total assets, showing how much of the assets are funded by the business’s own capital rather than debt. A higher net capital ratio indicates a larger equity cushion to absorb losses and support ongoing operations, which is the essence of solvency.

In contrast, liquidity measures like current ratio or working capital focus on short-term ability to cover current liabilities, not long-term sustainability. The debt-to-asset ratio looks at leverage, but it doesn’t directly convey how much of the assets are backed by the owners’ capital. So the net capital ratio best captures the long-run solvency of the business.