What is Solvency in Accounting?

Solvency is the company’s ability to meet its financial obligations when they fall due. This is a critical aspect of working capital management and directly affects the company’s survival and growth opportunities.

For an overview of relevant payment services and their accounting treatment, see What is a payment service? .

To improve credit risk, companies can obtain debt information from the Debt Register to get a more complete view of a customer’s unsecured debt.

What is Solvency?

Solvency, also called liquidity , refers to how easily a business can convert its assets into cash to meet short-term obligations. Good solvency ensures:

• Continuous operation without interruption in deliveries or services
• Credit trust with suppliers and financial institutions
• Growth opportunities through investments and expansion
• Competitive advantage by being able to exploit market opportunities quickly
• Financial stability which protects against financial shocks

The difference between solvency and solidity

It is important to distinguish between solvency and solidity:

Liquidity analysis and Key figures

Liquidity levels

Liquidity ratios are the most commonly used measures of solvency:

1. Liquidity level 1 (Current liquidity)

Likviditetsgrad 1 = Omløpsmidler ÷ Kortsiktig gjeld

Interpretation:

• Over 2.0: Very good ability to pay
• 1.5-2.0: Good ability to pay
• 1.0-1.5: Acceptable ability to pay
• Below 1.0: Weak ability to pay

2. Liquidity level 2 (Quick liquidity)

Likviditetsgrad 2 = (Omløpsmidler - Varelager) ÷ Kortsiktig gjeld

This rate excludes inventory which may be difficult to convert to cash quickly.

3. Cash rate (Immediate liquidity)

Kontantgrad = (Kontanter + Kortsiktige investeringer) ÷ Kortsiktig gjeld

Practical Example: Liquidity analysis

Let’s analyze the solvency of Example AS:

Calculations:

• Liquidity level 1: 2,500,000 ÷ 1,500,000 = 1.67
• Liquidity level 2: (2,500,000 - 800,000) ÷ 1,500,000 = 1.13
• Cash rate: 500,000 ÷ 1,500,000 = 0.33

Analysis: The company has an acceptable ability to pay, but is dependent on converting accounts receivable and inventory into cash.

Cash flow analysis

The meaning of Cash Flow

Cash Flow is the actual movement of cash into and out of the business. Even profitable businesses can have payment problems if cash flow is negative. Effective liquidity management is therefore essential to maintain good solvency.

Types Cash Flow

Cash Flow Forecast

A cash flow forecast is essential to predict solvency. For in-depth analysis techniques and strategies for cash flow optimization, see our comprehensive guide to Cash Flow Analysis .

Kontantbeholdning (slutt) = Kontantbeholdning (start) + 
                            Kontantinngang - Kontantutgang

Effective cash holdings requires strategic planning of both short-term and long-term cash needs.

Factors affecting ability to pay

Internal Factors

• Credit period to customers: Longer credit period reduces cash inflow
• Inventory rotation: Slow inventory turnover ties up capital
• Supplier credit: Longer payment term improves liquidity
• Seasonal variations: Affects both income and costs
• Investment decisions: Large investments can affect liquidity

External Factors

• Market conditions: Affects sales and payments
• Interest rate: Higher interest rates increase financing costs
• Business cycles: Recessions can delay customer payments
• Regulatory changes: New requirements may affect cash flow
• Currency fluctuations: For companies with foreign trade

Strategies to Improve Solvency

Short-term measures

Increase Cash Inflow

• Faster invoicing: Automate the invoicing process
• Shorter credit period: Reduce the payment deadline for customers
• Cash discounts: Offer a discount for prompt payment
• Effective collection: Follow up overdue invoices with payment reminders
• Factoring : Sell accounts receivable to factoring company for immediate cash flow

Reduce cash outflow

• Negotiate supplier credit: Get a longer payment period
• Optimize inventory: Reduce inventory tie-up
• Postpone investments: Prioritize critical acquisitions
• Cost reductions: Cut unnecessary expenses

Long-term Strategies

Structural Improvements

• Diversify customer base: Reduce dependence on large customers
• Improve product mix: Focus on profitable products
• Invest in technology: Automate processes
• Strengthen market position: Build competitive advantage

Financial Planning

• Establish credit lines: Secure access to financing
• Build cash reserves: Maintain liquidity buffer
• Monitor key figures: Implement dashboards and reports
• Scenario planning: Prepare for different market situations
• Budgeting : Systematic planning of cash flows and liquidity needs
• Alternative funding methods: Consider crowdfunding or crowdlending for quick capital access without traditional bank loans

Risk management and Solvency

Identification of Liquidity Risk

Liquidity risk occurs when the company cannot meet its payment obligations. Systematic liquidity management can help identify and manage such risks proactively. Early warning signs include:

• Falling liquidity levels over several periods
• Increasing accounts payable and delayed payment
• Reduced cash balance with no planned exit
• Difficulties in obtaining credit from banks or suppliers
• Increased interest costs due to higher risk premium

Contingency plans

A good liquidity readiness includes:

Solvency in Various Industries

Industry-specific challenges

Retail

• Seasonal variations: Large fluctuations in cash flow
• Inventory risk: A lot of capital tied up in inventory
• Short credit period: Customers often pay in cash or by card

Building and construction

• Long projects: Cash outflow before income
• Advance payments: Depending on customer advance
• Weather risk: Can affect progress and costs

Service provision

• Low capital tie-up: Less need for working capital
• Customer concentration risk: Dependence on large customers
• Competence risk: Loss of key people

Benchmarking

Comparison with industry averages is important to assess solvency:

Digital Tools for Solvency Analysis

Modern Solutions

Accounting systems

• Automatic reporting of liquidity key figures
• Integrated dashboards for real-time monitoring
• Forecast functionality based on historical data

Specialized Tools

• Cash Flow Planning: Detailed forecasts
• Credit monitoring: Automatic follow-up of accounts receivable
• Bank integration: Real-time account balance and transactions

Implementation of Monitoring Systems

An effective monitoring of solvency should include:

• Daily reporting of cash holdings
• Weekly forecasts for the coming 13 weeks
• Monthly analyses of liquidity key figures
• Quarterly benchmarking against the industry

Legal Aspects of Payment Problems

Consequences of Poor Ability to Pay

When the ability to pay fails, there can be serious legal consequences:

Bankruptcy risk

• Insolvency: Unable to pay overdue debts. See What is Insolvency? for more information.
• Illiquidity: Lack of liquid funds to cover obligations
• Bankruptcy petition: Can be brought forward by creditors or the company itself

Responsibility for the Management

• Duty of care: Management must act responsibly
• Information obligation: Notify the board of payment problems
• Responsibility for compensation: In the event of irresponsible continuation

Preventive measures

To avoid legal problems:

• Regular monitoring of ability to pay
• Early notification to the board in case of problems
• Professional advice in case of financial challenges
• Documentation of decisions and measures

Conclusion

Ability to pay is fundamental to any company’s survival and growth. Good liquidity management requires:

• Continuous monitoring of key figures and cash flow
• Proactive planning with forecasts and scenario analyses
• Balanced approach between growth and financial stability
• Contingency plans to handle challenges

By understanding and actively managing solvency, companies can ensure stable operations, exploit growth opportunities and build long-term competitive advantage. This requires both analytical skills, strategic thinking and operational discipline.

Remember that solvency is not just about survival - it’s about creating the basis for sustainable growth and value creation. A company with strong solvency has the freedom to invest, innovate and exploit market opportunities as they arise.