Chartered Financial Analyst (CFA) Level 1 Practice Exam

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What do solvency ratios measure?

The ability of the company to survive over a short period of time
The ability of the company to survive over a long period of time
The profitability of the company
The efficiency of asset utilization

The correct answer is: The ability of the company to survive over a long period of time

Solvency ratios measure the ability of a company to meet its long-term financial obligations. These ratios assess a firm's capacity to continue its operations over an extended period by evaluating its assets relative to its liabilities. A high solvency ratio indicates that a company has enough assets to cover its long-term debts, which is crucial for long-term viability. The focus on long-term stability is essential for stakeholders who are interested in the sustainability of the company’s operations and its financial health over time. This contrasts with other measures, such as liquidity ratios, which assess short-term financial health, or profitability and efficiency ratios that relate to income generation and asset utilization, respectively. Thus, the primary purpose of solvency ratios is to ensure that the company can endure financial challenges and maintain operations in the long run.