Question

The ability of a business to pay its debts as they come due and to earn a reasonable amount of income is referred to as
a. solvency and leverage
b. solvency and profitability
c. solvency and liquidity
d. solvency and equity

Answer 1

Concepts and reason

Solvency and profitability are two critical elements of a business over which it thrives. These are aspects which are absolutely poles apart in definition but yet are interdependent. Both are the metric of the financial health of the business.

Fundamentals

Solvency: - This is defined as the metric that indicates the company’s financial health on both long term and short-term basis. It indicates the company’s current position of the assets with respect to the liabilities held by the company. The solvency of the company is assessed by the lenders before issuing any new loans.

Liquidity: - This is termed as the degree to which a specific security or the asset held be sold in the market to generate cash out of it. It should not affect the price of the asset. The company or the business may utilize the liquid assets from time to time to meet the short-term debt and any sort of obligations a company faces while running the business.

Profitability: - This aspect deals with the business ability to generate profits at periodic intervals. It tells us or indicate us the profitability of the business after it covers the operational expense of running the business. The business always works towards the activity or focuses on the line of business that delivers good and exceptional profits to the business.

Equity: - This is defined as the amount of money that business owes to the shareholders of the company. The shareholders provide initial capital to start the business. If the business has to be liquidated on any given day then the business should be able to pay off the amount to the shareholders.

The business has to pay the debt as and when the lender demands the money from the business. The company has to pay the debt from its internal funds or from the profits generated by the business.

The ability of the business to pay the debts owed against them indicates the company has enough funds on hand. The business is also offering good services to earn reasonable profits on hand.

Ans:

The business’ ability to pay its debt as and when they are due and to earn reasonable amount of income is termed as solvency and profitability.