Solvency (solvabiliteit)
The ratio between equity and total capital, also called the solvency ratio; a measure of long-term resilience. Often calculated as equity divided by balance sheet total.
What does solvency (solvabiliteit) mean?
The ratio between equity and total capital, also called the solvency ratio; a measure of long-term resilience. Often calculated as equity divided by balance sheet total.
The common ratio of equity divided by balance sheet total shows the share of financing provided by the owners. The result differs from liquidity, which concerns short-term payments. Banks may use adjusted definitions.
How does it work?
Solvency measures what part of the balance sheet total is financed with equity: equity divided by total capital, times 100%. The higher the percentage, the more loss the company can bear before creditors are affected. The KVK names 25% to 40% as what lenders consider healthy, with the caveat that the norm differs per industry, type of business and lender.
The law prescribes no ratio, but does mention the concept: the annual accounts must, insofar as their nature permits, enable a sound judgement on solvency and liquidity (art. 2:362(1) DCC). A bank can use its own definition in the credit agreement, for example by counting subordinated loans; the subordination itself is stated in the notes (art. 2:375(4) DCC).
Example
A BV has € 200,000 balance sheet total and € 60,000 equity: solvency 60,000 / 200,000 = 30%. It buys a machine for € 100,000, fully financed with a bank loan. Equity stays € 60,000, the balance sheet total becomes € 300,000 and solvency drops to 20%, without a single euro of loss having been suffered. If the BV then pays € 15,000 dividend, it falls further: 45,000 / 285,000 = 15.8%. If the bank requires at least 25% in the covenant, that limit was already breached by the investment.
In the annual accounts
Ratio derived from the balance sheet; not a mandatory separate item.
Difference from liquidity
Solvency is about the long term: is there enough equity to absorb setbacks? Liquidity is about the short term: can the bills of the coming months be paid? A BV with a paid-off business premises and an empty bank account is solvent but not liquid; an online shop with a full till and negative equity is the reverse.
Common mistakes
- Seeing a high ratio as proof of available cash
- Ignoring negative equity
What to watch for
- Statutory reserves count as equity but are not distributable: a high solvency says nothing about room for dividend.
- The filed balance sheet of a micro BV shows equity and liabilities each as one item (art. 2:395a(4) DCC), enough for the ratio. From small upwards you also see the composition of equity (art. 2:396(3) DCC).
- Calculate it yourself: ratio calculator.
Legal basis and sources
no separate statutory ratio
Frequently asked questions
What is a good solvency?
According to the KVK, lenders consider 25% to 40% healthy. The norm differs per industry, type of business and lender.
What does a negative solvency mean?
Then equity is negative: according to the balance sheet the debts exceed the assets. That is not yet bankruptcy, but the board must be able to substantiate that the company will keep paying its debts.
What is the solvency ratio and how do I calculate it?
The solvency ratio is another name for solvency: equity divided by the balance sheet total, as a percentage. With € 100,000 equity and a balance sheet total of € 400,000 that is 25%. Both amounts are on the balance sheet: the equity item and the total of the assets.
Which variants of the solvency ratio exist?
Three common ones: equity divided by total capital, equity divided by debt capital, and the debt ratio (debt capital divided by total capital). With € 100,000 equity, € 300,000 debt capital and a balance sheet total of € 400,000 that gives 25%, 33.3% and 75%. If a bank counts a subordinated loan of € 40,000 from the debt capital as equity, the ratio is (100,000 + 40,000) / 400,000 = 35%. So check which definition is in the agreement when applying for credit.
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Preparing Dutch annual accounts?
Your first set of annual accounts is free, for every size class. Create an account and prepare the annual accounts of your Dutch company under Title 9 of Book 2 of the Dutch Civil Code.
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