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Business Studies

Solvency

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All businesses need to assess how they are performing and solvency is indication of this. There are a number of simple calculations used to assess solvency.

Working capital

A business is solvent if it can meet its short-term debts when they are due for payment. To do this it needs adequate working capital.

There are three main reasons why a business needs adequate working capital. It must:

  1. Pay staff wages and salaries.
  2. Settle debts and therefore avoid legal action by creditors.
  3. Benefit from cash discounts offered in return for prompt payment.

You can calculate a firm's working capital by using the following equation:

working capital = current assets minus current liabilities

Many groups of people are interested in the published accounts of a company. The information they provide may influence future decisions. For example, lenders will be looking at the solvency of a business.

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