Short Term vs Long Term Solvency Ratio: Difference and Comparison

Short-term solvency ratios, like the current ratio, assess a company’s ability to meet immediate obligations using current assets. Long-term solvency ratios, such as the debt-to-equity ratio, gauge a company’s ability to meet long-term obligations by evaluating its debt in relation to equity. Both ratios offer insights into different time frames of a company’s financial stability.

Key Takeaways

  1. Short-term solvency ratios assess a company’s ability to meet its short-term financial obligations, while long-term solvency ratios evaluate its ability to meet its long-term financial obligations.
  2. Key short-term solvency ratios include the current and quick ratios, which measure liquidity. In contrast, key long-term solvency ratios include the debt-to-equity ratio and the debt ratio, which measure financial leverage.
  3. A higher short-term solvency ratio indicates better liquidity, while a lower long-term solvency ratio suggests a lower level of financial risk.

Short Term vs Long Term Solvency Ratio

The difference between short-term and long-term solvency ratios is that Short term solvency ratio indicates the company’s current assets divided by the current liabilities. At the same time, Long term solvency suggests the company’s net worth divided by total debt obligation in the market.

Short Term vs Long Term Solvency Ratio
/10

Finance Quiz

Test your knowledge about topics related to finance

1 / 10

What is a mortgage?

2 / 10

Bank overdraft is a good source of finance for _________.

3 / 10

What is a diversified portfolio?

4 / 10

What is the stock market?

5 / 10

What is a financial advisor?

6 / 10

Common People can deal in stock exchange through?

7 / 10

What is the difference between stocks and bonds?

8 / 10

What is the yield curve?

9 / 10

What is a Roth IRA?

10 / 10

What is the formula for calculating compound interest?

Your score is

0%

Both these terms are linked to a company’s economic, financial, and business status. However, we may discuss the differences between them.


 

Comparison Table

FeatureShort-Term Solvency RatioLong-Term Solvency Ratio
FocusCompany’s ability to meet short-term obligations (within 1 year)Company’s ability to meet long-term obligations (more than 1 year)
ExamplesCurrent Ratio, Quick Ratio, Cash RatioDebt-to-Equity Ratio, Debt-to-Assets Ratio, Interest Coverage Ratio
ImportanceAssesses ability to pay bills, secure loans, avoid financial distressAssesses financial stability, future sustainability, and riskiness for long-term investors
InterpretationHigher ratio indicates better short-term liquidityHigher ratio indicates better long-term financial health and ability to manage debt
Ideal rangeVaries by industry, but >1 for current ratio, >1 for quick ratio, and >0.1 for cash ratioNo single benchmark, but debt-to-equity < 2 and debt-to-assets < 0.5 considered healthy
LimitationsCan be distorted by accounting practices and timing issuesMay not fully capture future risks and uncertainties
Use in conjunction with other financial analysisDebt ratios, profitability measures, industry analysisLiquidity ratios, cash flow statements, business model analysis

 

What is Short Term Solvency Ratio?

Short-term solvency ratios, also known as liquidity ratios, measure a company’s ability to meet its short-term financial obligations. These ratios provide insights into the firm’s liquidity and its capacity to cover immediate liabilities with its readily available assets.

Current Ratio

The current ratio is a key short-term solvency ratio calculated by dividing a company’s current assets by its current liabilities. It reflects the company’s ability to cover short-term obligations with its short-term assets. A ratio above 1 indicates the firm has more current assets than liabilities, suggesting good short-term solvency.

Quick Ratio (Acid-Test Ratio)

The quick ratio is a more stringent measure of short-term solvency, excluding inventory from current assets. It considers only the most liquid assets like cash, accounts receivable, and marketable securities. A higher quick ratio implies a better ability to meet short-term obligations without relying on selling inventory.

Cash Ratio

The cash ratio is the most conservative short-term solvency ratio, considering only cash and cash equivalents in relation to current liabilities. This ratio provides a strict assessment of a company’s ability to settle its immediate debts using only its available cash.

short term solvency ratio
 

What is Long Term Solvency Ratio?

Long-term solvency ratios, also known as leverage ratios, focus on a company’s ability to meet its long-term financial obligations and manage its long-term debt. These ratios help assess the financial risk associated with a firm’s capital structure and its capacity to sustain long-term financial commitments.

Debt-to-Equity Ratio

The debt-to-equity ratio is a fundamental long-term solvency ratio calculated by dividing a company’s total debt by its total equity. This ratio measures the proportion of financing provided by creditors compared to shareholders. A higher debt-to-equity ratio suggests a higher level of financial leverage, indicating higher financial risk.

Interest Coverage Ratio

The interest coverage ratio evaluates a company’s ability to meet its interest payments on outstanding debt. It is calculated by dividing the company’s earnings before interest and taxes (EBIT) by its interest expenses. A higher interest coverage ratio indicates a better capacity to fulfill interest obligations, signaling lower financial risk.

Debt Ratio

The debt ratio assesses the proportion of a company’s assets financed by debt. It is calculated by dividing total debt by total assets. A lower debt ratio signifies a lower reliance on debt for financing, indicating a more conservative capital structure and lower long-term solvency risk.

long term solvency ratio

Main Differences Between Short-Term and Long-Term Solvency Ratios

  • Time Horizon:
    • Short-Term Solvency Ratios: Focus on a company’s ability to meet immediate financial obligations within a year or the operating cycle.
    • Long-Term Solvency Ratios: Assess a company’s ability to fulfill long-term financial commitments and manage obligations beyond one year.
  • Components Considered:
    • Short-Term Solvency Ratios: Include current assets and current liabilities, emphasizing liquidity elements like cash, receivables, and inventory.
    • Long-Term Solvency Ratios: Examine the company’s long-term debt, equity, and assets, emphasizing the capital structure and financial leverage.
  • Purpose:
    • Short-Term Solvency Ratios: Provide insights into a company’s ability to handle immediate financial challenges and maintain day-to-day operations.
    • Long-Term Solvency Ratios: Assess the financial risk associated with a company’s capitalization and its capacity to meet long-term debt obligations.
  • Measurement Period:
    • Short-Term Solvency Ratios: Typically cover a 12-month period or the company’s operating cycle, focusing on the near future.
    • Long-Term Solvency Ratios: Extend beyond one year, providing a more extended outlook on the company’s financial health and sustainability.
  • Examples:
    • Short-Term Solvency Ratios: Current ratio, quick ratio, cash ratio.
    • Long-Term Solvency Ratios: Debt-to-equity ratio, interest coverage ratio, debt ratio.
  • Risk Evaluation:
    • Short-Term Solvency Ratios: Assess the immediate risk of the company facing liquidity issues and being unable to meet short-term obligations.
    • Long-Term Solvency Ratios: Focus on evaluating the financial risk associated with a company’s capital structure and its ability to manage long-term debt commitments.
References
  1. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=375880
  2. https://www.jstor.org/stable/2490168

Last Updated : 11 February, 2024

dot 1
One request?

I’ve put so much effort writing this blog post to provide value to you. It’ll be very helpful for me, if you consider sharing it on social media or with your friends/family. SHARING IS ♥️

25 thoughts on “Short Term vs Long Term Solvency Ratio: Difference and Comparison”

  1. The detailed comparison table and in-depth analysis are highly informative, shedding light on the critical differences between short-term and long-term solvency ratios. A commendable resource for individuals involved in financial analysis and decision-making.

    1. Avatar of Marshall Yvonne
      Marshall Yvonne

      Absolutely, the details and interpretations provided in this article support a thorough comprehension of these financial metrics for effective financial planning and risk management.

    2. This article serves as a valuable guide for financial practitioners, offering valuable insights into short-term and long-term solvency ratios and their significance in financial analysis.

  2. Avatar of Pauline Robertson
    Pauline Robertson

    The clear explanations and definitive examples of short-term and long-term solvency ratios truly enhance the readers’ understanding of these fundamental financial metrics. This article serves as a valuable resource for professionals in finance and investment.

    1. I completely agree with your assessment. This article’s depth and clarity significantly contribute to the comprehension of these ratios for practical use in financial analysis.

    2. The breakdown of short-term and long-term solvency ratios provides a robust understanding of financial stability assessment. The examples and interpretations are elucidating and impactful.

  3. The breakdown of short-term and long-term solvency ratios and their respective components is insightful and enriching. This article is a valuable resource for professionals and students seeking a comprehensive understanding of these critical financial metrics.

    1. I couldn’t agree more. The inclusion of real-world examples and the practical implications of these ratios enhance the educational value of this article.

    2. The comprehensive explanations of short-term and long-term solvency ratios, along with their significance and interpretations, make this article an essential reference for financial analysis.

  4. Avatar of Richardson Keith
    Richardson Keith

    The detailed descriptions of short-term and long-term solvency ratios, along with the in-depth analysis of their components, make this article an essential read for individuals involved in financial assessment and investment decisions.

    1. Avatar of Campbell Arthur
      Campbell Arthur

      Absolutely, the comparison table, interpretation, and examples provide a solid foundation for understanding and applying these ratios in different financial contexts.

  5. This article successfully defines and explains the significance of both short-term and long-term solvency ratios in evaluating a company’s financial standing. The examples and ideal ranges provided further enhance the understanding of these metrics.

    1. The breakdown of the interpretations and the importance of these ratios in financial decision-making is particularly insightful. It serves as a valuable resource for anyone involved in financial analysis.

    2. The focus on use in conjunction with other financial analyses and the main differences between short-term and long-term solvency ratios offer a well-rounded perspective on financial evaluation.

  6. The clarity and depth of this article’s content provide a thorough understanding of short-term and long-term solvency ratios. It serves as a valuable educational resource for individuals involved in financial assessment and risk management.

    1. Absolutely, the detailed breakdown of these financial metrics and their implications contribute to an enhanced understanding of financial stability assessment.

    2. Avatar of Williams Jessica
      Williams Jessica

      This article’s emphasis on practical applications and its comprehensive overview of short-term and long-term solvency ratios make it an indispensable guide for financial practitioners.

  7. This article effectively elucidates the fundamental concepts of short-term and long-term solvency ratios, contributing to a holistic understanding of financial evaluation techniques.

  8. This article provides a comprehensive and informative breakdown of short-term and long-term solvency ratios. It helps readers understand the importance of these ratios and how they differ in their assessment of a company’s financial stability.

    1. I completely agree. The detailed comparison table and explanations of key ratios are particularly helpful in clarifying the concepts.

  9. The distinction between short-term and long-term solvency ratios is well articulated in this article. It’s essential to recognize the different financial aspects they reveal about a company’s operations.

    1. Absolutely, understanding these ratios allows investors and analysts to make informed decisions based on a company’s financial health in both the short and long term.

    2. It’s clear that these ratios provide a deeper insight into a company’s financial position, making them vital tools for financial evaluation and risk assessment.

  10. Avatar of Collins Dennis
    Collins Dennis

    The comparison of short-term and long-term solvency ratios highlights the importance of considering different time frames in financial analysis. This is crucial for a comprehensive assessment of a company’s fiscal stability.

    1. I couldn’t agree more. The limitations and interpretation of these ratios are crucial points to consider while making financial decisions.

Leave a Comment

Your email address will not be published. Required fields are marked *

Want to save this article for later? Click the heart in the bottom right corner to save to your own articles box!